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Focus: Financial Services – August 2006

Regulatory trends in the region

In brief: As financial service businesses in our region look to expand their markets, they must be aware of the varied regulatory and legal environments in which they want to operate. Our Asian team looks at the current regulatory trends.

Australia
Managing conflicts

In Australia, some recent high-profile corporate collapses have motivated regulatory authorities to require financial service providers to put in place systems to manage conflicts of interest.

The Australian Securities and Investments Commission (ASIC) has released a policy statement on managing conflicts which requires a financial services licensee to have arrangements and a system in place to identify and manage, control, avoid and disclose all conflicts of interest.1 Regulatory intervention and the imposition of conditions can result as a consequence of failing to manage, control or avoid a conflict of interest.

Managing conflicts of interest in the financial services industry

In April 2006, ASIC released a discussion paper on managing conflicts of interest in the financial services industry.2

The discussion paper uses hypothetical case studies illustrating real or perceived conflicts of interest across the financial services industry to explain ASIC's views on how those conflicts should be managed. A number of the case studies are loosely based on real-life examples of conflicts ASIC has seen recently.

There are various examples provided in relation to conflicts between:

  • Financial advisers (wholesale) and research report providers including: conflicted research; selective publication; pressure to make favourable recommendations; poor disclosure of interests; product issuer with an interest in research house; agreements to provide positive research on a client; research staff crossing information barriers and proprietary trading.
  • Licensees/financial advisers (retail) including: commission only remuneration; buyers of last resort; relationship between product issuer and adviser; shelf fees; payments for switching funds; insurance brokers and cluster groups; bulky statements of advice.
  • Product issuers/fund managers including: directed brokerage; asset management advice; related entities; embedded termination benefit for responsible entity.
Use of administrative powers in enforcing financial services laws

ASIC has issued a new guide,3 to help financial services industry participants better understand ASIC's powers of enforcement.

The key factors taken into consideration in deciding to take administrative action include:

  • the nature and seriousness of the suspected misconduct;
  • the internal controls on the licensee or person;
  • the conduct of the licensee or person after the misconduct occurs; and
  • the previous regulatory record of the licensee or person.

ASIC says that while each matter is assessed on a case-by-case basis, the examples in the guide are intended to provide transparency around how ASIC determines the most appropriate response.

Breach reporting

ASIC has reissued its guide4 to reporting breaches, which includes a new section explaining how it handles breach notifications and what ASIC takes into account in deciding what, if any, further action to take. It also explains what licensees can do to reduce the need for ASIC to take further action. ASIC has developed a template form for lodging written breach reports which is available on ASIC's website at www.asic.gov.au/forms.

Relationship between listed entities and analysts

The Financial Services Institute of Australasia (FINSIA) has released its exposure draft Principles for building better relations between Listed Entities and Analysts (March 2006) in partnership with the Australasian Investor Relations Association (AIRA). While these principles do not have the force of law they are intended to establish ethical benchmarks which entities and analysts should uphold. The six principles are briefly summarised below:

  • Free flow of information – Analysts and listed entities should not do anything to disrupt the free flow of information required for market integrity;
  • Integrity of analyst research – Analysts should issue objective research/recommendations;
  • Dissemination of research reports by analysts – Analysts should not deliberately withhold or delay dissemination of significant research reports;
  • Fair and transparent access to listed entities for analysts – Listed entity representatives should not delay or restrict access to company information in an attempt to influence analysts;
  • Listed entities factual validation of analyst reports – If analysts elect to provide reports prior to publication, listed entities may choose to review these but only for the purpose of verifying factual information; and
  • Appropriate use of the media – Listed entities and analysts should try to resolve differences privately, only using the media as a last resort.

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People's Republic of China

In China the need to respond to the growing demand from off-shore companies to operate in the PRC has seen the development of a major new policy.

Qualified Foreign Institutional Investors scheme

The Qualified Foreign Institutional Investor (QFII) program enables foreign funds management companies, insurance companies, securities companies, and other asset management institutions which have been approved by the China Securities Regulatory Commission (CSRC) to invest in A shares which are listed in China and denominated and traded in Reminbi (RMB).

The CSRC has issued draft regulations that will allow the QFII investor to open and manage multiple securities sub-accounts in the joint names of the QFII investor and any 'public funds, insurance funds, pension funds and government investment funds'. This will have a major impact on offshore entry into the PRC market.

International accounting standards and conversion of non-tradeable stock

The CSRC has stated that PRC listed companies will adopt International Accounting Standards from 2007 and improve corporate disclosure.

In addition, the May announcements indicate that the conversion of non-tradeable stock into tradeable shares will be converted by the end of 2006. Historically, up to two-thirds of the stock in listed PRC companies has been in non-tradeable shares which have generally been held by the State.

Moratorium on IPOs lifted

After a year long suspension, the PRC government has announced the resumption of initial public offerings.

Asset and mortgage-backed securities

The CSRC has announced that it will pilot projects for asset and mortgage-backed securities. The precise details are not yet available.

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Hong Kong

The Hong Kong market has generally been moving towards greater liberalisation. At the same time attempting to apply greater standards of risk management.

Funds – Real Estate Investment Trusts

The Hong Kong Securities and Futures Commission (SFC) has recently been flexible in applying the Real Estate Investment Trusts (REIT) Code in a number of key areas:

  • A Hong Kong Retail REIT may now be permitted to have minority ownership of properties up to a maximum aggregate amount of 10 per cent of its net asset value.
  • The SFC has been comparatively flexible in permitting yield enhancement arrangements, such as management fee waivers and the use of 'step up' interest swap hedging arrangements on borrowings.

The SFC has also announced that it will soon be considering the regulation of mergers and acquisitions of Hong Kong listed REITs, which are not currently covered by the Hong Kong Code on Takeovers and Mergers.

Corporate finance – new requirements

The SFC will introduce new eligibility criteria and on-going obligations for sponsors on 1 January 2007 in the Guidelines for Sponsors and Compliance Advisers. The changes are likely to impact more on smaller players in the market and they should review their internal systems and controls and documentary records should be created to ensure compliance with on-going requirements.

Asset management – profits tax exemption to offshore funds

Amendments to the Inland Revenue Ordinance, which extend the exemption to Hong Kong profits tax to a broader range of offshore funds, have been passed. Non-resident funds can be exempt even though not authorised by the SFC or regulated by overseas regulatory authorities or bona fide widely held.

SFC – power to fine

The SFC now has power to fine brokers and other licensed persons up to HK$10 million. There are plans to extend the power of the SFC to fine companies and directors for breach of the Listing Rules of The Stock Exchange of Hong Kong. The market reform bill which will include the above proposed changes is schedule to come before the Legislation Council in October 2006.

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Singapore
Changes proposed to Banking Act

On 31 July 2006, the Monetary Authority of Singapore (MAS) released a consultation paper proposing changes to the Banking Act. According to MAS, the proposals seek to strengthen prudential safeguards, facilitate risk-based supervision, provide banks with greater flexibility and update banking regulations. Key proposals include:

  • Revision of methodologies for limiting concentration risk and related party exposures in line with international best practice. This will include applying limits on all exposures to a single counter-party or group of related counter-parties posing a single risk, instead of just on credit facilities.
  • Establishment of an asset maintenance framework for foreign bank branches: MAS proposes to require foreign bank branches to maintain a minimum level of eligible assets in Singapore in proportion to their liabilities. This change has been proposed to improve the recovery of assets by depositors in the event of the failure of a foreign bank branch in Singapore.
  • Amendment of the priority ranking of deposit liabilities of a bank: Presently, both non-bank and inter-bank deposit liabilities of a bank rank ahead of other unsecured liabilities in the event of a winding-up. MAS has proposed that all non-bank deposit liabilities be accorded priority ranking ahead of other unsecured liabilities (including inter-bank liabilities).
  • Enhancement of MAS's role in bank resolution: The changes would give MAS wider powers in connection with the resolution process involving failed banks, including the ability to direct the sale of the business of a failed bank to another bank.
  • Removal of the statutory reserve fund requirement: In light of other prudential safeguards, MAS is proposing to lift the requirement that banks maintain a reserve fund and allow banks to release reserved funds over a five-year period.
Code on Take-Overs and Mergers

On 21 June 2006, the Securities Industry Council of Singapore (the Council) released a consultation paper outlining proposed changes to the Singapore Code on Take-Overs and Mergers (the Code). The key proposed changes include:

  • in respect of foreign-incorporated companies and foreign business trusts, clarification that the Code only applies to those with a primary listing in Singapore;
  • amendments so that REITs structured as collective investment schemes would fall within the ambit of the Code;
  • discretion for the Council to waive the provisions of the Code in respect of certain entities that have a primary listing outside Singapore or are unlisted public companies;
  • clarification of the application of concert party rules in the context of financial assistance;
  • amendments to also require disclosure of information to a competing offeror for asset deals that involve the acquisition of assets or businesses which represent 20 per cent or more of a targets' sales, earnings, assets or market capitalisation;
  • introduction of a 1 per cent cap on break fees;
  • settlement of a takeover within 10 days of it becoming unconditional, compared to 21 days currently; and
  • extension of the whitewash waiver validity period from two to five years for convertible instruments and options.
Listing of Hedge Funds Accepted

With effect from 29 June 2006, Singapore Exchange Ltd (SGX) will accept listing of hedge funds. Units in listed hedge funds will not be traded on the SGX. However, by listing hedge funds on the SGX, these funds will be more visible to institutional and accredited investors through more rigorous disclosure standards. There will be a less onerous continuing listing obligations regime for hedge funds as compared to conventional funds and the applicable SGX rules will also facilitate a faster listing process.

The relevant listing requirements include the following:

  • if intended to be offered to the public, the fund must be authorised or recognised under section 286 or 287 of the Securities and Futures Act, otherwise the fund may be offered only to institutions and/or accredited investors;
  • the fund must have a minimum asset size of at least S$20 million or US$20 million for Singapore and foreign currency denominated funds respectively;
  • units in the hedge fund will not be traded; and
  • the hedge fund investment manager is expected to have at least one principal with a minimum of five years relevant investment management experience.

Continuing obligations for hedge funds include disclosure of the hedge fund's net asset value per unit within seven business days after each month end and announcement of any material changes to its operation or governance.

Business trusts

In May 2006, investors were invited to take part in the first public offer of a business trust in Singapore. Recent legislative developments in Singapore have facilitated the establishment of registered business trusts (Business Trusts). The legislation seeks to align the regulation of Business Trusts with the regulation of companies. However, unlike a company, which may only pay dividends from accounting profits, a Business Trust may declare and pay distributions to its unitholders out of its operating cash flows, provided the board of directors of the trustee-manager is satisfied that the Business Trust is able to meet its liabilities as they fall due.

This feature makes business trusts an attractive structure for the establishment of businesses with large up-front capital outlays, stable operations, and strong cash flows such as large infrastructure projects and property developments.

Business Trusts differ from passive investment instruments such as unit trusts, which are regulated as Collective Investment Schemes (CIS) under the Securities and Futures Act. As CIS investors entrust their money with a financial intermediary for management, the CIS regime seeks to ensure that the financial institution observes prudential safeguards to protect that money (including requiring a separate and independent manager and trustee). The activities of Business Trusts are, on the other hand, more comparable to that of companies, and as a result, day-to-day operations of Business Trusts are not closely regulated.

Proposed amendments to Code on Collective Investment Schemes

The MAS has recently proposed amendments to the Code on Collective Investment Schemes (the CIS Code). The proposed amendments relate to two areas: the single party limit; and investment by a CIS in financial derivatives.

  • Single party limit and group limits

Currently, the CIS Code provides that a CIS, such as a REIT for instance, may only invest up to the higher of:

  • 10 per cent of the deposited property of the CIS in securities issued by, and deposits placed by, the same entity (which is defined to include a company, its subsidiaries, fellow subsidiaries and holding company);  and
  • the benchmark weighting of the issuer.

In keeping with the European Union's Undertakings for the Collective Investment of Transferable Securities (UCITS) guidelines, the proposed amendments would raise the cap to 20 per cent in relation to an 'entity' (as currently defined). This proposal has been made in recognition of the fact that the 10 per cent limit may be unduly restrictive in circumstances where some conglomerates have a number of related companies in their stable which would come under the definition of 'entity'. The single party limit for each reference benchmark security would be the higher of 10 per cent of the deposited property of the scheme or the benchmark weight of the security.

  • Investment in financial derivatives

Under the CIS Code, a CIS is currently only permitted to invest in financial derivatives for the purpose of:

  • hedging existing positions in a portfolio; or
  • efficient portfolio management (provided such derivatives are not used to gear the overall portfolio).

MAS is proposing to bring the CIS Code into line with the European Union's UCITS III guidelines by amending the Code so that a CIS will be allowed to invest in financial derivatives up to a cap of 100 per cent of the deposited property of the scheme if adequate risk management procedures and controls are in place.

MAS issued a consultation paper in relation to these two proposed amendments in May.

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Thailand

Thailand is currently attempting to develop a long-term strategy to encourage fundraising and savings options, including encouraging institutional investors into the share market.

Bank of Thailand regulations
Issue of baht bonds by foreign entities

With the aim of developing the infrastructure and encouraging diversification of the Thai bond market, foreign financial institutions and governments may issue baht denominated bonds with the approval of the Bank of Thailand (BOT).

Capital Market Master Plan II – 2006 to 2010

In February, the Stock Exchange of Thailand (SET) together with the Federation of Thai Capital Market Organisations launched the Thai Capital Market Master Plan II, which sets out the road map for Thai capital markets from 2006 to 2010. The purpose of the plan is to enhance the efficiency of the Thai stock market as a fundraising and savings option for companies and individuals.

Some of the key goals the plan seeks to achieve across the equity market and bond market include:

increasing the proportion of institutional investors from 10 per cent to 20 per cent of market turnover;

  • working with listed companies to adjust P/E ratios to better reflect their actual value;
  • raising the standard of listed companies by offering incentives and privileges;
  • encouraging greater participation by retail investors; and
  • encouraging cross listings of bonds within ASEAN.
SEC consultation on independent directors and audit committees

In Thailand, listed companies must have independent directors and audit committees. The Securities and Exchange Commission (SEC) determines who qualifies as an independent director and audit committee and the scope of their work. In May, the SEC announced a review of the qualification rules. A number of significant proposed changes are:

  • audit committees must be comprised of directors of the company;
  • independent directors and audit committee members must not hold more than one per cent of shares in the company (currently five per cent); and
  • at least two members of the audit committee must reside in Thailand.

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Indonesia

In December 2005, the Minister of Finance merged the capital market regulator (Bapepam) and the Directorate General of Financial Institutions to become one institution, Bapepam and Financial Institutions. The policy of this institution will be expected to be a risk-based approach.

Disclosure documents

The prospectus of a public offering (which must be in the Indonesian language) must not contain untrue statements regarding important and relevant information and must not omit to state any important and relevant information that would be required so that the prospectus would not be misleading. Also, the issuer and underwriters must be careful in the use of photos, diagrams and tables which might be misinterpreted by investors. The issuer, underwriters, valuers, public accountants and legal consultants have their respective roles and responsibilities to determine and disclose all the material information to be easily read and understood by the public and investors.

Private placements

Private placements of shares on behalf of publicly listed corporate clients are not subject to the new public offering regulations. Private placements can be made overnight, off-market to investors. However, private placements which meet certain criteria (eg investor must hold 25 per cent or more of the issued shares, or directly/indirectly controls the issuer) are subject to tender offer procedures. The issuer is still liable for ensuring that the market is fully informed with material information.

Managing conflicts

Bapepam regulations also govern the code of conduct and illicit behaviour of the securities companies (acting as underwriter, investment manager and/or broker-dealer) and investment advisors in connection with the client relationship.

Underwriters must disclose in the prospectus any affiliation or other material relationship between the underwriter and the issuer. A broker-dealer must disclose in advance any interest in the securities recommended to its clients and transaction with clients which are for the interest of it or its affiliates. A broker-dealer is prohibited from carrying out transactions on behalf of investors without, or not in accordance with, their clients¡| instructions. An investment manager and investment advisor must disclose in writing to its client if there is a conflict of interest which may lead to a lack of objectivity.

Recent changes
  • To provide better protection to the investor, Bapepam has issued a new regulation on guidelines for mutual funds.
  • Bapepam is currently preparing several drafts of regulations on investment advisors acting as securities rating companies and representative agents of mutual fund sellers and periodic reporting by securities companies.
  • The Government has submitted a Bill to amend current laws on foreign and domestic investment in order to encourage foreign investment and provide greater legal certainty for investors. The Bill will remove discrimination between foreign and domestic investors in respect to certain tax issues, and will require all capital investors be treated in the same manner.
  • The Minister of Finance has introduced a guarantee scheme for mitigating political risk, project performance risk and demand risk in major infrastructure projects in order to encourage investment. In essence, the scheme provides a level of state support in the event that major infrastructure projects are adversely affected by certain events.

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Conclusion

As we can see from a brief review of the jurisdictions above there are many important changes that need to be navigated by offshore entities wishing to do business in the region. While a new asset class in Singapore and the Qualified Foreign Institutional Investors scheme in the PRC are positive moves to encouraging external investment, other policy initiatives are looking to diminish risk and create a more rigorous regulatory environment.

What will be important to know is how each of these jurisdictions implements and polices these new policy initiatives as a way of providing a level of certainty for overseas businesses.

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Regional contacts

Our financial services team provides financial services regulatory advice to clients across the Asia Pacific region and assists with structuring transactions, developing and selling financial products and managing assets. For further information, please contact the partners listed below.

Footnotes
  1. [PS-181] Licensing – Managing conflicts of interest.
  2. [PS-121] Managing conflicts of interest. (Comments closed on 9 June)
  3. Licensing: administrative action against financial services providers – an ASIC guide (April 2006).
  4. Breach reporting by AFS Licensees: an ASIC guide.

 

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