Companies and financial institutions across Asia face an increasing challenge in complying with regulations formulated on the other side of the world. Here, we consider the extent to which regulations such as EMIR, Dodd-Frank and FATCA have impacted the region and examine the intended (and unintended) consequences for treasurers and their banking partners.
The regulatory challenges facing companies in Asia are manifold. As a result, the cost of compliance in the region is high – and new regulations are pushing this up even further. According to the most recent Thomson Reuters Cost of Compliance Survey, 29% of Asian firms spent more than ten hours per week tracking and analysing the impact of regulatory developments in 2014, up from 21% in 2013. The equivalent figures for US and UK firms in 2014 were 25% and 21% respectively.
When it came to the number of companies whose compliance teams were spending more than seven hours per week amending policies and procedures to reflect the latest regulatory rules, the disparity between Asia and the US and UK was even greater: almost three in ten (29%) of Asian firms fell into this category last year, compared with 23% in 2013. Only 19% of US firms and 17% of UK firms spent more than seven hours per week amending policies and procedures in 2014. So which regulations in particular have been piling on the pressure in Asia?
Global OTC derivatives
Derivatives reform has been one of the headaches. For example, reports that the International Swaps and Derivatives Association (ISDA) asked the Basel Committee on Banking Supervision and the International Organisation of Securities Commissions (IOSCO) to delay derivatives trading reforms highlight the specific challenges of implementing new rules beyond the US and Europe.
In mid-2014 the Australian Securities and Investments Commission (ASIC) launched a consultation on proposed changes to trade reporting rules and the Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission in Hong Kong began a consultation on requirements relating to mandatory reporting and related record keeping obligations. The Securities and Futures (Amendment) Ordinance 2014 was enacted in March 2014, which provides a broad regulatory framework for the over-the-counter or OTC derivatives market in Hong Kong.
The new regime introduces mandatory reporting, clearing and trading obligations of OTC derivative transactions in line with G20 commitments in reforming the global OTC derivatives markets. It is expected that mandatory reporting and related record keeping obligations will be introduced into the Hong Kong Legislative Council for vetting in the first half of 2015. The rules will become effective upon the completion of the vetting process.
“Our current priorities are to consult on the first phase of mandatory clearing requirements and the expansion of the product scope of mandatory reporting,” explains a HKMA spokesperson. “We will deal with reporting requirements on other entities afterwards.”
Australia’s rules relating to mandatory reporting of OTC derivatives have already been enacted. In February, ASIC amended its derivative transaction rules. Sonia Goumenis, Partner at Australian commercial law firm Clayton Utz, says the G20 agreement to improve transparency in the OTC derivatives market has had a significant impact in the country, particularly on banks that are well entrenched in the cross-border OTC derivatives markets. This is either by virtue of being physically present in those jurisdictions and booking trades through overseas branches, or trading with counterparties (clients) located in foreign jurisdictions and therefore possibly being caught by regulations in those jurisdictions.
“To some extent, ASIC has borrowed heavily from the regulatory approach in the US and across Europe,” adds Clayton Utz’s John Tawadrous, a lawyer with experience working on the OTC reform programme at one of the major Australian banks while on secondment last year.
Other Asian jurisdictions which are not members of the G20 have been guided by its recommendations in terms of mandatory reporting and clearing as well as capital requirements for non-centrally cleared trades according to Tom Jenkins, Partner at KPMG China. “Countries in this region with an OTC derivatives market – including India, China, Japan, Korea, Malaysia and Singapore – have initiated reforms, with an initial focus on mandatory reporting.
“Japan is probably furthest down the line in terms of OTC derivatives market reform in Asia. The country has implemented mandatory reporting and some mandatory clearing since November 2012 and indicated that mandatory trading on electronic platforms will be introduced by September 2015.” Jenkins observes that the range of instruments covered by the first phase of mandatory reporting and clearing is more limited in Asia than it was in either Europe or the US. But he also points to the fact that Hong Kong and Australia in particular are not that far behind their Western counterparts, while China introduced mandatory clearing for interest rate swaps much more quickly.
PwC’s Asia Pacific Financial Services Risk Leader, Chris Matten, says Dodd-Frank has created a knock-on effect across the region. US banks operating in Asia face restrictions on proprietary trading; this has forced some to consider their booking models to see whether certain transactions can be booked through an Asian subsidiary. In particular, the Volcker provision of Dodd-Frank has forced banks to look at where transactions are booked.
Many Asian financial institutions do not trigger the thresholds for the Volcker Rule to apply, so only a few would be challenged by the requirements explains Akihiko Katayama, Director at AlixPartners. “But for those impacted, some have implemented very complex manual processes that have added operational risks and unnecessary costs.”
According to Niall Coburn, Regulatory Intelligence Expert at Thomson Reuters, many corporates across Asia remain uncertain about how EMIR and Dodd-Frank affect them. There are also some questions in relation to requirements around additional registration, reporting and documentation and the circumstances that firms have to act upon in order to be compliant. “The most significant outcome in terms of documentation following years of regulatory activity in the US and EU manifests itself in the form of protocols to which certain counterparties are bound to adhere to when entering into certain OTC derivative transactions.
“Hong Kong and Singapore appear to have both brought their regulations in line with the major jurisdictions with a ‘substituted compliance’ approach. As a result of EMIR and Dodd-Frank, the Singapore, Hong Kong and Australian markets have handled these new complex regulations and appear to be operating effectively.”
Levels of preparation
One regulation for which Asian financial institutions have been well prepared is Basel III. Stricter capital requirements are nothing new to those banks in the region who experienced the Asian crisis of the late 1990s. Matten explains that there are a number of Asian countries (including Japan, Hong Kong, Singapore and Indonesia) that are full members of the Basel community. “Historically, many regulators in the region followed the provisions of Basel – albeit with a slight delay. Banking is a global business and if you are a jurisdiction that is not part of this community it makes sense to follow the provisions around capital adequacy.”
Coburn observes that Asian regulators, as well as the region’s financial institutions, have made considerable progress towards implementation of Basel III. Asian banks are well poised to meet its requirements and most regulators in the region have indicated their acceptance of moving towards standard rules on the basis that it will make their institutions more resilient against a financial crisis.
However, he also suggests that it is difficult for regulators to finalise policies when the Basel Committee is still consulting on some of the most important areas, such as the capital floor framework which will affect central issues such as capital ratios and relevant risk-weighted model calculations. “Since the G20 Brisbane Summit, regional regulators have been working together and accepted the need to have an improvement in consistency and comparability in bank capital ratios and an improved approach in calculating internal risk-weighted ratios that have, in the past, have been inconsistently applied.
“In Asia, the banks appear to accept that higher bank capital is inevitable to assist them in improving their resilience to any future financial crisis. The only question remaining is what those ratios will be and the outcomes of the current Basel consultation in relation to capital framework.”
In Australia, the Financial System Inquiry Report (published in December 2014) had already foreshadowed the need for banks to adjust their capital ratios to ensure the financial system is less likely to be dependent on government support in the event of any failure. This report has been accepted as a working benchmark for other governments and regulators in making their markets more efficient and secure.
According to Coburn, Asian regulators respect the work of the Financial Stability Board and the Basel Committee – but they also recognise that it may take some time and patience for reforms to be implemented. This does not mean to say that Asian banks don’t feel hard done by. Asian financial institutions have frequently pointed out that having been better capitalised they were not impacted by the global financial crisis – so why should they have to accept the same measures as European and US banks? “Having said that, Singapore always had higher minimum capital requirements than the Basel framework and continues to do so,” adds Matten.
AlixPartners’s Katayama agrees that most Asian banks are in relatively good shape with regard to Basel III requirements. In his view, liquidity requirements are more of a challenge, with holding sufficient liquidity and daily liquidity reporting continuing to be major challenges. Michael Brevetta, Head of US Regulations at PwC, says that on the issue of FATCA compliance, a good deal of work remains to be done. “For example, banks in countries that don’t have inter-governmental agreements in place (such as Vietnam) may have had issues fulfilling reporting requirements.” Financial institutions across Asia are still reviewing pre-existing accounts. “This is a process that could last into 2016.”
Foreign financial institutions (FFIs) in Asia have been advised to review customer activity dating back to mid-2008 and beyond to ascertain whether they may be exposed to the scrutiny of US tax authorities based on information that may already be in the hands of the US Internal Revenue Service (IRS) or the Department of Justice (DOJ).
An additional complicating factor is that many Asian countries which have reached agreements with the IRS have yet to release guidance for local financial institutions. “International banks are very focused on FATCA and are mostly compliant with the legislation,” says Coburn. “There have not been any violations or investigations that I am aware of that would indicate that regional firms are not complying.”
Knowing your procedures
On the question of the extent to which ‘Know Your Customer’ (KYC) and anti-money laundering (AML) regulations are being effectively implemented across Asia, Neill Poole, Executive Director at AlixPartners, says financial institutions are constantly trying to recruit staff for their AML teams and asking for help with training. “This suggests to us that not all companies are ahead of the curve. As in other parts of the world, the region is seeing financial institutions abandoning certain classes of customer on the basis of perceived risk.
“However, this only serves to drive such business into less regulated sectors, which can have a detrimental effect overall on effective implementation of AML regulations.” Poole believes that effective anti-money laundering regulations require a risk-based approach, whereas some financial institutions are applying a rule-based or ‘tick the box’ approach in order to ensure they comply with local regulations.
“This can result in the units responsible for investigation of suspicious transaction reports being overloaded with reports of largely innocent transactions. Until all financial institutions get to the stage where they can single out genuinely suspicious transactions more successfully from the surrounding ‘noise’ of legitimate transactions, implementation of AML regulations will not be truly effective.”
The challenge in applying KYC processes and anti-money laundering rules effectively across Asia is that they are principles-based, adds Matten. “Even if the rules have not changed, the regulators’ interpretation of what they mean in practice can shift significantly, which makes it difficult for institutions to know whether they are compliant.”
According to Coburn, Asian financial institutions and firms have taken compliance with the anti-money laundering and counter-terrorist financing laws very seriously. “There is also increased emphasis on beneficial ownership. Even countries such as Malaysia are taking a heightened compliance approach given the rise of ISIS funding from the region.
“Asian regulators have introduced enhanced requirements over the past few years and anti-money laundering professionals in the region are also growing more concerned about how regulatory challenges will affect their business.” AML compliance has become more focused in the past five years and regulators are now pressurising financial institutions and firms to make sure they meet best practice standards.
Fit for purpose?
When determining whether Asian regulators have been proactive in terms of implementing Western regulations and/or developing regional regulations, Coburn refers to an opinion that European regulations do not necessarily fit into the financial market structure in Asia; most of the obligations are brought about by the presence of global institutions.
“There is, however, an over-arching acceptance that international best standards are the way forward to ensure that institutions are more resilient and are more able to face another financial crisis. Hong Kong, Singapore and Australia have led the way in ensuring that the financial sector adheres to cross-border regulatory requirements. In some respects, they have a more focused vision of what works in the Asian region than regulators in Europe and America.”
China has indicated that it is striving to meet international best practice in many regulatory areas and Japan has introduced a new corporate governance code for listed companies in line with international best practice. “It is fair to say that Asian regulators are playing an important part in promoting international governance through the Financial Stability Board, the Basel Committee and IOSCO, which will also help enhance regulatory and financial stability in the region,” adds Coburn.
But while Asian regulators have made progress elevating the awareness of the need for more effective compliance among financial institutions, many Asian jurisdictions still lag behind the US and UK, concludes Poole. “If Asian regulators want to drive change and implement a robust culture of compliance among their constituents, they should consider holding individual members of boards of directors responsible and accountable in order to achieve the right ‘tone from the top’.
“Though continual progress is being made, it won’t be clear how deeply rooted these initiatives are within organisations until regulators enforce their policies as vigorously as some of their Western counterparts.”