FISD General Meeting in Asia Regulation in a Changing Industry: The - - PowerPoint PPT Presentation

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Regulation in a Changing Industry: The Drive Towards Transparency

Andrew Sheng Chairman Securities and Futures Commission 23 September 2004

FISD General Meeting in Asia

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♦ 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?

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♦ 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?

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♦ 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 …

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♦ 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

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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

• r 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

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♦ 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

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♦ 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

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SFC Initiatives on Improving Market Transparency

♦ Dual Filing on IPO Prospectuses ♦ Statutory backing for Listing Rules ♦ Consultation on the regulatory framework for addressing analyst conflicts of interest ♦ Review of the regulatory framework for public

• ffering of securities

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♦ 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

• bligations 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

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♦ 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

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♦ In a fully centralized market with a single method

• f 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

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♦ 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

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♦ 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

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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 …

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♦ Transparency ♦ Best execution ♦ Client identification and verification ♦ Beneficial owner identification ♦ Know your client

Process automation and global standards can help meet these requirements

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♦ 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?

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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

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FinNet in Hong Kong

Standard Internet technology ⇒ Interoperability Single network multiple services

⇒ Convenient ⇒ Low cost ⇒ Facilitate STP

Secure private B2B & G2B network ⇒ e-transactions ⇒ sensitive information exchange Robust & reliable ⇒ Guaranteed uptime ⇒ on-time delivery

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♦ 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

• f 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

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♦ 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

• pportunities to streamline processes

G30 Recommendation #1

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♦ 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
• pen, standardized, IP-based protocols for securities

transactions.

 FinNet

G30 Recommendation #2

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♦ 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

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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

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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

• f 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?

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♦ 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

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Thank You