In Hong Kong, Hong Kong Monetary Authority (HKMA) and Securities and Futures Commission (SFC) are the financial regulators in banks and securities industry respectively. HKMA Background Hong Kong Monetary Authority, the government authority in Hong Kong, is responsible for maintaining monetary and banking stability. It was set up on 1 April 1993 by merging the Office of the Exchange Fund and the Office of the Commissioner of Banking. Its main functions and responsibilities are governed by the Exchange Fund Ordinance and the Banking Ordinance. Functions of HKMA The key functions of HKMA are: to keep the Hong Kong dollar stable; to manage the Exchange Fund; to promote the safety of Hong Kong's banking system; and to develop Hong Kong's financial infrastructure so as to enable money to flow smoothly, freely and without obstruction. Departments involved in HKMA Responsibility is shared among three departments within the HKMA: The Banking Supervision Department handles the day-to-day supervision of authorized institutions, The Banking Policy Department formulates supervisory policies to promote the safety and soundness of the banking sector, and The Banking Development Department formulates policies to promote the development of the banking industry. Three-tier Banking System Hong Kong maintains a three-tier system of deposit-taking institutions, namely, licensed banks, restricted licence banks, deposit-taking companies. They are collectively known as authorized institutions (A.I.) under the banking Ordinance. Only licensed banks may operate current and savings accounts and accept deposits of any size and maturity. Restricted licence banks are principally engaged in merchant banking and capital market activities. They may take deposits of any maturity of HK$500,000 (approx. US$ 64,103.) and above. Deposit-taking companies are mostly owned by, or associated with banks. They engage in a range of specialized activities, including consumer finance and securities business. These companies may take deposits of HK $100,000 (approximated US$12,821) or above, with an original term to maturity of at least of three months. Hong Kong has one of the highest concentrations of banking institutions in the world. 73 of the largest 100 banks in the world have an operation in Hong Kong. At the end of May 2003, there were 135 licensed banks, 43 restricted licence banks and 40 deposit-taking companies in business. They are totally 218 authorized institutions. In addition, there are 92 local representative offices of overseas banks in Hong Kong. Supervision of authorized institutions Under the Banking Ordinance, the HKMA is the licensing authority responsible for the authorisation, suspension and revocation of all three types of authorised institutions. The HKMA conducts periodic reviews of the authorisation criteria and, when necessary, introduces amendments to reflect the changing needs of the regulatory environment and to meet new international standards. It also ensures that only fit and proper institutions are entrusted with public deposits. Regulatory Framework The Banking Ordinance provides the legal framework for banking supervision in Hong Kong. Under section 7(1) of the Ordinance, the principal function of the Monetary Authority is to promote the general stability and effective working of the banking system. In 1999 , the Hong Kong Monetary Authority (HKMA) has complies with the Core Principles of international standards suggested by the Basle Committee on Banking Supervision ("Basle Committee"). Continuous Supervisory Approach The supervisory approach of HKMA is based on a policy of "continuous Supervision". It involves on-going monitoring of institutions using a wide variety of techniques which are aimed at detecting any problem at an early stage. Here is the operational supervision conducted by HKMA. 1. On-site examinations including those on: - money laundering (tier-two exams for 2002) - treasury - securities - e-banking - review of business continuity plans - overseas examinations 2. Off-site reviews and prudential interviews 3. Tripartite meetings 4. Meetings with the boards of directors of AIs 5. Approval of applications to become controllers, directors, chief executives, alternative chief executives of AIs 6. Reports commissioned under Section 59(2) of the Banking Ordinance 7. Cases considered by the Banking Supervision Review Committee 2001 2002 232 (58) (10) (17) 0 0 (11) 236 78 19 440 285 (32) (11) (10) (30) (20) (12) 215 78 21 318 5 0 9 10 (Source: HKMA Annual Report 2002) Risk-based supervision The HKMA is also developing a more formalized risk assessment approach and quality assurance programme. The approach puts emphasis on evaluation of the quality of risk management practices and internal controls of various types of risks faced by the institutions. Here are the risks they may consider: Credit Risk - The risk arising from the potential that a borrower or counter-party will fail to perform on an obligation. Interest Rate Risk - The risk to an institution's financial condition resulting from adverse movements in interest rates. Market Risk - The risk to an institution's condition resulting from adverse movements in market rates or prices, such as foreign exchange rates, or commodity/equity prices. Liquidity Risk - The risk that an institution will be unable to meet its obligations as they come due. Operational Risk - The risk arising from the potential that inadequate information systems, operational/transactional problems (relating to service or product delivery), breaches in internal controls, fraud or unforeseen catastrophes. Reputation Risk - The risk that negative publicity regarding an institution's business practices. Legal Risk - The risk arising from the potential that unenforceable contracts, lawsuits or adverse judgements Strategic Risk - The current and prospective impact on earnings or capital arising from adverse business decisions, improper implementation of decisions, or lack of response to industry changes. CAMEL Rating The HKMA has adopted the CAMEL rating system to assess the financial condition and overall soundness of authorised institutions in Hong Kong. "CAMEL" rating system is an internationally recognised framework for assessing the Capital adequacy, Asset quality, Management, Earnings and Liquidity of banks. The primary purpose of CAMEL is to help identify institutions whose weaknesses in financial condition, compliance with laws and regulations, and overall operating soundness require special supervisory attention. The overall rating is expressed on a scale of one to five in ascending order of supervisory concern: "1" indicates the highest rating and least degree of concern; "5" represents the lowest rating and highest degree of concern. Capital Adequacy Ratio (CAR) It is the ratio of an authorised institution's capital base to its risk-weighted credit exposures. The method and components used in the calculation are specified in the Third Schedule to the Banking Ordinance. Locally incorporated authorised institutions are required to adhere to the minimum 8% capital adequacy ratio, but the HKMA may increase the ratio to: (a) not more than 12% in the case of a bank; or (b) not more than 16%, in the case of a deposit-taking company or a restricted licence bank. Each locally incorporated authorised institution is assigned a minimum ratio on an unconsolidated (solo) basis or on a consolidated and unconsolidated basis within the range specified by the Ordinance. Supervision of Liquidity The HKMA assesses the adequacy of an institution's liquidity by examining six factors, including liquidity ratio, maturity mismatch profile, ability to borrow in the interbank market, intra-group transactions, loan to deposit ratio, and diversity and stability of the deposit base. This approach aims at ensuring, as far as possible, that institutions can meet their obligations when they fall due in normal circumstances and that an adequate stock of high quality liquid assets is maintained to provide them with a breathing space in the event of a liquidity crisis. Loan Classification System In December 1994, the HKMA introduced a loan classification system requiring authorised institutions to report their assets on a quarterly basis according to a standardized framework. Under the system, loans are classified as Pass, Special Mention, Substandard, Doubtful or Loss, with the latter three categories collectively regarded as "classified assets". Derivatives and Risk Management The HKMA adopts a three-pronged approach in developing its supervisory framework for managing the risks of Authorised Institutions derivatives activities: Controls (to ensure that AIs have adequate internal control systems to manage the risks of their derivatives activities); Capital (to ensure that AIs have adequate capital to support possible losses in their derivatives business); and Capability (to ensure that there is adequate expertise within the HKMA to develop risk management policies and to supervise AIs' derivatives activities). Financial Disclosure Increased transparency in financial reporting serves to enhance Hong Kong's position as an international financial centre, demonstrating the financial strength of Hong Kong's banks as well as providing relevant and comparable information to financial analysts and credit rating agencies. As a result, in addition to the annual disclosure standards for locally incorporated authorized institutions, the HKMA has also issued guidance in respect of the interim financial disclosure by locally incorporated institutions and the half-yearly financial disclosure by overseas incorporated institutions. Under this guideline, authorised institutions incorporated in Hong Kong (except for the smaller restricted licence banks and deposit-taking companies) are required to disclose certain financial information, including: income statements, balance sheets, cash flow statements, asset quality, in particular information on overdue and rescheduled assets, off-balance sheet exposures, maturity profiles, segmental information, foreign currency exposures, risk management, capital adequacy; and liquidity information. SFC Historical background of SFC In 1987, the deficiencies in the structure were made all too apparent by the October crash, which resulted in the closure of both the Hong Kong stock and stock index futures markets for four days. After the crash, a six-member committee, the Securities Review Committee was created to examine Hong Kong's regulatory structure and how they could be improved, to minimise the chances of a repeat of the disruption of October 1987. In May 1988, the Committee released its report. The Securities Review Committee recommended existing structure should be replaced with a single statutory body outside the civil service. The Securities and Futures Commission (SFC), which is the regulator of HK Securities Industry, was born in 1989 under the Securities and Futures Commission Ordinance. SFC is an independent, non-governmental statutory body. The SFC regulates the securities and futures markets in Hong Kong and oversees the development of these markets. The chairman of SFC and executive directors were appointed by the government. Roles and functions: Licensing and supervision of intermediaries and focus on secondary market; Encouraging market development; and Protecting investors. Regulatory objectives: Maintain and promote the fairness, efficiency, competitiveness, transparency and orderliness of the securities and futures industry; Promote understanding by the public of the operation and functioning of the securities and futures industry; Provide protection for members of the public investing in or holding financial products; Minimize crime and misconduct in the securities and futures industry; Reduce systemic risks in the securities and futures industry; and Assist the Financial Secretary in maintaining the financial stability of Hong Kong by taking appropriate steps in relation to the securities and futures industry. Operational divisions in SFC Corporate Finance Division Administer the Takeovers and Mergers Code and Share Repurchases Code; Promote fair and equal treatment of public shareholders; Raise standards of investor protection and corporate governance; Oversee the Stock Exchange's listing-related functions and responsibilities; Review and recommend changes to the Listing Rules; Administer securities and company legislation relating to listed and unlisted companies; Facilitate the development of effective and efficient capital markets for issuers, including Mainland enterprises; and From 1 April 2003 onwards, review prospectuses and other documents sent by listed companies to their shareholders. Intermediaries and Investment Products Division The Licensing Department acts as the gatekeeper of the industry, ensuring that only fit and proper individuals and organisations are allowed to deal with investors and other market participants. The Intermediaries Supervision Department monitors and supervises the financial viability and business conduct of intermediaries; raises the standards of control and risk management of intermediaries to protect investors; devises balanced policies and regulations to promote market integrity and development; and maintains ongoing dialogue with market participants to uplift industry standards. The Investment Products Department authorises investment products for sale to the Hong Kong public in accordance with product codes and industry standards; monitors marketing materials and disclosures of funds; formulates policies for the development of new products; strengthens international regulatory co-operation in relation to collective investment schemes and their operators; and conducts annual survey on the fund management activities in Hong Kong. Supervision of Markets Division Supervise and monitor the activities of the exchanges and clearing houses; Facilitate the development of and encourage participation in the Hong Kong markets; Strengthen market infrastructure; and Oversee and manage Hong Kong's investor compensation funds. Enforcement Division Enforce laws relating to the securities and futures industry, leveraged foreign exchange trading, and investment arrangements; Report suspected insider dealing to the Financial Secretary; Inspect books and records of listed companies if impropriety is suspected; Enforce disclosure of interests of substantial shareholders, directors and chief executives of listed companies; Suppress illegal or improper practices in trading, investment arrangements and the provision of advice or other financial services; and Co-operate with domestic and overseas regulatory bodies in investigations in Hong Kong and overseas. Responsibility of SFC The Securities and Futures Commission exercises prudential supervision over the securities, futures and financial investment industries in Hong Kong. All rules made by the two Exchange and the Clearing Houses are subject to SFC approval. To administer requirements to ensure full disclosure and fair treatment of the investing public; To monitor trading on the securities and future markets to detect possible malpractices; To conduct periodic inspection visits of registered persons and makes inquiries in response to public complaints about misconduct; To inspect a listed company’s books and records if its directors are suspected improperly in the management of affairs; To regulate the takeovers and merger activity; regulation of offers of investment products; financial intermediaries other than SEHK and HKFE members. To handle any dissatisfied party and disciplinary matters by the Takeovers and Mergers Panel. Powers in relations to offences and misconduct The SFC has three methods to take actions when there are companies who misconduct their behaviours by: Prosecution, Court order, and Revocation. Disciplinary actions and civil and criminal actions range from private or public censure to revocation of a license. Regarding criminal actions, SFC is responsible for the investigation of various criminal offences and while it prosecutes minor offences, serious matters are prosecuted at the independent discretion of the Director of Public Prosecution. On summary conviction Fine $100,000 6 months’ imprisonment On indictment Fine $ 10,000,000 7 years’ imprisonment