040923sheng

Regulation in a Changing Industry: The Drive Towards Transparency: 

Regulation in a Changing Industry: The Drive Towards Transparency Andrew Sheng Chairman Securities and Futures Commission 23 September 2004 FISD General Meeting in Asia

What is market transparency?: 

Timely access to accurate and reliable information is a market fundamental. In stock market terms, wide and timely availability of both pre-trade and post-trade information, e.g. price, order size, trading volume, should be available to traders and investors. Ability to identify the beneficial owner depends on The willingness of participants to show; The exchange’s ability to publicly display; and The regulatory requirements to publish trade and order information What is market transparency?

Why is market transparency important?: 

Central to both the fairness and efficiency of a market (ie price discovery and market integrity) The more complete and more widely available is trading information, The more efficient the price discovery process; and The greater the public’s confidence in its fairness Timely access to trading information allows investors to better look after their own interests, make the right judgment and reduces risks of manipulative or other unfair trading practices Why is market transparency important?

Transparency can be a two-edged sword …: 

Some traders may stay out of the market because they prefer anonymity Those interested in larger trades may see immediate disclosure as likely to turn the market against them Appropriate level of transparency in any particular product market is a regulatory question Transparency can be a two-edged sword …

Drivers of market transparency: 

Globalisation of financial markets (increasing cross-border trading) Proliferation of electronic order routing and electronic trading platforms Increasing retail participation in OTC markets Increasing regulatory requirements on client and beneficial owner identification Drivers of market transparency

Securities and Futures Ordinance enshrines market transparency: 

SFC Regulatory objectives: To maintain and promote its fairness, efficiency, competitiveness, transparency and orderliness; To promote understanding by the public of its operation and functioning; To provide protection for members of the public investing in or holding financial products; To minimize crime and misconduct; To reduce systemic risks; and To assist the Financial Secretary in maintaining the financial stability of Hong Kong. Securities and Futures Ordinance enshrines market transparency

IOSCO’s three core objectives of securities regulation includes transparency: 

The protection of investors Ensuring that markets are fair, efficient and transparent The reduction of systemic risk Principle 27: Regulation should promote the transparency of trading. IOSCO’s three core objectives of securities regulation includes transparency

Global transparency requirements varies: 

In scope, statutory backing and degree of enforcement Some jurisdictions (eg Hong Kong) set high-level requirements only and address them primarily through main market operators, i.e. exchanges Others (eg U.S.) establish broader and more detailed requirements through broker-dealers or their bank equivalents Global transparency requirements varies

OTC markets are less transparent … but this is changing: 

Increasing retail participation in OTC markets (e.g. bond markets) driving need for greater transparency The International Securities Market Association (ISMA) upgraded TRAX, originally a trade matching system, to enable its subscribers to comply with transaction reporting obligations to regulatory authorities and exchanges In the U.S., TRACE was launched by NASD to enhance regulatory reporting and market transparency by capturing and disseminating post-trade information on more than 4,200 bonds. 65% of the reported trades are “retail trades” (representing less than 2% of the total value) OTC markets are less transparent … but this is changing

IOSCO’s recommended core measures to promote transparency in the corporate bond market: 

Transparency To assess the appropriate level of transparency to facilitate price discovery and market integrity Regulatory framework To obtain information regarding its characteristics To implement trade reporting requirements To have in place appropriate information gathering and surveillance methods or systems Consolidation To determine whether there are any impediments to consolidation and whether regulatory action is required, if trading data is not consolidated IOSCO’s recommended core measures to promote transparency in the corporate bond market

Transparency alone insufficient for market integrity in fragmented market: 

In a fully centralized market with a single method of trading (such as Hong Kong), there should be little dispute as to what constitutes best execution Best execution (GP2 of Code of Conduct) - A licensed or registered person when acting for or with clients should execute client orders on the best available terms. Retail and institutional investors are now demanding best execution terms Transparency alone insufficient for market integrity in fragmented market

Client Due Diligence process is important to fighting fraud & market abuse: 

Client Due Diligence (“CDD”) process is today key securities regulatory requirements for control of credit and reputational risks (eg Anti-money laundering, terrorist funding etc) CDD encompasses: Client and beneficial owner identification and verification Know your client (“KYC”) – obtain adequate information about your client’s circumstances and investment objectives Maintaining records of related data Should be carried out by authorized securities services providers (“ASSPs”) Client Due Diligence process is important to fighting fraud & market abuse

Recent FATF 40 recommendations 2003  + 8 Special Recommendations on Terrorist Financing: 

Apply to money laundering + terrorist financing Enhanced due diligence measures for: Beneficial owner / Omnibus accounts Non-face-to-face transactions Politically exposed persons Simplified CDD in certain circumstances Impose specific conditions where third parties reliance is placed Basic obligations under CDD and keeping of client identity record to be included in law and regulation Recent FATF 40 recommendations 2003 + 8 Special Recommendations on Terrorist Financing

IOSCO Principles on Client Identification and Beneficial Ownership 2003: 

Client identification and verification – when establishing a business relationship with a client, ASSPs should identify and verify the client’s identity using reliable, independent source documents, data or other information. Beneficial owner identification – ASSPs should obtain sufficient information, in order to identify persons who beneficially own or control securities accounts. Know your client – ASSPs should obtain from each client information about the client circumstances and investment objectives relevant to the services to be provided and should conduct ongoing due diligence regarding the client’s accounts. Record keeping – ASSPs should keep records on the Client Due Diligence process for at least five years after the business relationship is ended. IOSCO Principles on Client Identification and Beneficial Ownership 2003

SFC follows these requirements …: 

Obligations of licensed persons with the SFC: Client identification GP4 of Code of Conduct - A licensed or registered person should be satisfied on reasonable grounds about: the identity, address and contact details of the person ultimately responsible for originating the transaction; and the person that stands to gain and/or bear risk; and the instruction given by the person Know your client KYC is an integral part of fair dealing requirements GP4 of Code of Conduct - A licensed or registered person should seek from its clients information about their financial situation, investment experience and investment objectives relevant to the services to be provided. Record keeping and retention Customer due diligence and suspicious transactions reporting Continuous education and training SFC follows these requirements …

Powers of the SFC in combating Money Laundering/ Terrorist Financing: 

To supervise, monitor and regulate the activities of licensed persons To enforce the proper conduct (including the adoption of appropriate internal controls), competence and integrity of licensed persons To sanction wrong doers To share information with and provide assistance to other regulatory authorities Powers of the SFC in combating Money Laundering/ Terrorist Financing

SFC contributions to AML initiatives: 

Guidance Note on Money Laundering (SFC will revise the Guidance Note to reflect the latest FATF recommendations and IOSCO principles) Alert letters and circulars to disseminate names of designated terrorists Seminars to promote awareness On-site inspection to monitor compliance Collaboration with Security Bureau, JFIU and fellow regulators to enhance the AML regime SFC contributions to AML initiatives

Process automation and global standards can help meet these requirements: 

Transparency Best execution Client identification and verification Beneficial owner identification Know your client Process automation and global standards can help meet these requirements

A shorter settlement cycle?: 

T+2 settlement in Hong Kong Time difference with the rest of the world Efforts to shorten settlement cycle have slowed down The focus is now on further straight-through processing which requires Further process automation Communication standards harmonization/convergence A shorter settlement cycle?

SFC role in promoting process automation and adoption of global standards: 

1999 SCEFI REPORT identified process efficiency and global standards key to Hong Kong competitiveness SFC: Chairs Technical Committee of the IOSCO Chairs Asia Regional Monitoring Committee of G30 recommendations on clearing and settlement Member, CPSS-IOSCO Task Force on Recommendations for CCPs Participates in Financial Stability Forum Promoting Hong Kong EDGAR (website of websites to allow investor access to market information) SFC role in promoting process automation and adoption of global standards

G30 Recommendations – Global marketplace should have global norms : 

We have global markets, but local processes, laws, systems, customs and market practices For efficiency and robustness, global users and providers of clearing and settlement services anxious for the emergence of global standards G30 recommendations focus on building a strengthened, interoperable global network; mitigating risk; and, improving governance Key is to increase safety, reduce investor costs and strengthen market efficiency for international clearance and settlement of securities Implementation of G30 recommendations adds transparency to the global system G30 Recommendations – Global marketplace should have global norms

G30 Recommendation #1: 

Eliminate paper and automate communication, data capture and enrichment To eliminate the issuance, use, transfer, and retention of paper securities certificates Scripless securities market initiative To automate elements of the process, such as confirmations and trade allocations, that introduce other forms of paper into the securities processing transaction flow To use electronic communication to transmit information for all instruments and transaction types and to identify opportunities to streamline processes G30 Recommendation #1

G30 Recommendation #2: 

Harmonize messaging standards and communication protocols To adopt ISO15022 as the global standard for straight-through securities messaging across the entire securities life cycle. CCASS/3 accepts ISO 15022 messages To adopt XML (eXtensible Mark-up Language) over time To support and use communication networks that adopt open, standardized, IP-based protocols for securities transactions. FinNet G30 Recommendation #2

G30 Recommendation #3: 

Develop and implement reference data standards To identify, develop and adopt universal securities, counterparty and relevant generic reference data standards ISIN, BIC Issuers, exchanges, and other originators and distributors of data should make all relevant information available to the market in compliance with these standards for a fair price and on a timely basis. G30 Recommendation #3

The Drive Towards Transparency: 

The Drive Towards Transparency Market transparency support market efficiency foster investor confidence enable regulators to conduct market surveillance Investors Investors Investors Investors Client Identity - protect market integrity Technology development reduces the costs for greater transparency interoperability promoted by international setting bodies building blocks for implementation of a shorter settlement cycle

How can the market data industry help?: 

Promote adoption of international standards Identify, develop and adopt a reference data standard for counterparty identification Currently BIC is only for identification at corporate entity level Should we go to client and beneficial owner level? Harmonize/converge the standards among different sectors of the financial services industry Currently the securities and banking industry sectors have different client identification requirements … but the sectors are linked on the payment of securities transactions How can the market data industry help?

Markets are built by market participants: 

Market efficiency and transparency depends on market partnership SFC committed to work with market participants for:- Fair, efficient and transparent market, where Investor interests are protected Systemic risk is reduced Markets are built by market participants

Slide28: 

Thank You