SFC expects complete institutional risk assessments by end of September

SFC expects complete institutional risk assessments by end of September

The SFC’s updated AML guidance comes into effect at the end of this month and reminds us all of the importance of the institutional risk assessment, or IRA. The consultation conclusions and amendments to the Guideline on Anti-Money Laundering and Counter-Financing of Terrorism were published on 16th September with most of the changes coming into effect on the 30th.

The SFC’s consultation was first published in September 2020 and so Licensed Corporations (LCs) have had plenty of warning of the changes coming. But the short implementation deadline of 30th September for most of the changes has taken some LCs by surprise.

While the new guidelines contain specific requirements for brokers and fund managers, there are updates which are applicable to all Licensed Corporations. Given the regulator expects compliance almost immediately, it’s vital to familiarise yourself with the changes and put in place updates to your policies, training and IRAs where necessary.

AML guidance – changes for all firms

As we highlighted in our article when the September 2020 consultation was launched (SFC consults on AML guidelines), the main change under the Updated AML Guideline is to reinforce the expectation for conducting and documenting the institutional risk assessment (IRA). This is an important call to action for all firms to review their IRA approach, since it is very common that the IRA is badly documented by LCs, or in some rarer cases has not been drafted. The Updated Guideline makes it clearer that the IRA should be a distinct element of an LCs AML control framework, and that it should be updated at least every two years.

The IRA should be specific to the LC and set out how the LC is vulnerable to AML and CFT risks, and how they are mitigated. A number of risk factors should be included, including customer risk, country risk, product and service risk among others. The IRA must also demonstrably be understood and signed off by senior management. We have been helping lots of LCs with their IRA since the consultation was published, and we can assist with how to tackle this.

AML guidance – changes for fund managers

Also included in the Updated AML Guideline are possible additional measures to take in the case of enhanced due diligence. For example, this includes the scenario when a Hong Kong manager is appointed as sub-manager of an offshore fund vehicle:

Examples of possible enhanced measures in relation to RBA

“…(i) where an FI is being appointed by a customer that is an asset management company located in a place outside Hong Kong to provide discretionary asset management services in relation to an investment vehicle and does not have a business relationship with the investment vehicle, where appropriate, obtaining additional customer information such as the underlying investor base (e.g. background and geographical location of the underlying investors of the delegated investment vehicle), the reputation of the delegating asset management company (e.g. whether it has or had been subject to any targeted sanctions, ML/TF investigations or regulatory actions) and its AML/CFT controls; obtaining senior management approval and understanding respective AML/CFT responsibilities clearly.”

Updated illustrative indicators of suspicious transactions and activities have also been included in the guidance, for different types of customer behaviour and different types of transaction. There is no specific guidance that covers the scenario of transaction monitoring for a fund manager, although some of the guidance under the heading of ‘related to settlement and movement of funds and securities’ can be inferred to apply to the scenario of monitoring for suspicious subscriptions and redemptions in and out of the funds under management. For example, with some interpretation applied, the suspicious ‘red flag’ indicators can be easily adapted for a fund manager, for example:

  • Requests for subscriptions and redemptions to and from jurisdictions posing higher risk without reasonable explanation, which are not consistent with the investor’s declared business dealings or interests
  • Relevant for discretionary account managers, the involvement of offshore companies on whose accounts multiple transfers are made, especially when they are destined for a tax haven, and to accounts in the name of offshore companies of which the customer may be a shareholder
  • Requests for redemptions to be made to different persons from the original investor without reasonable explanation.

AML guidance – changes for brokers

The Updated AML Guideline includes a new section (4.20) dedicated to cross-border correspondent relationships. “Correspondent Relationships” refers to the provision of services for conducting transactions, which constitutes dealing in securities, dealing in futures contracts, or leveraged foreign exchange trading for which an FI is licensed or registered, by the FI (hereafter referred to as “correspondent institution”) to another financial institution located in a place outside Hong Kong (hereafter referred to as “respondent institution”), whether the transactions are effected by the respondent institution on principal or agency basis. In other words, omnibus accounts. Unlike the other changes introduced in the Updated AML Guideline, the Correspondent Relationship changes will not come into force for another six months, on 30th March 2022.

Section 4.20 brings in extensive new guidance setting out the expectations for managing the risks associated with correspondent relationships, and for impacted clients a review of policy and procedure is an important priority. New guidance includes topics on:

  • Effective procedures to mitigate risk
  • Additional prescribed measures for cross-border correspondent relationships
  • Minimum requirements in applying the RBA
  • Direct access to underlying clients to correspondent accounts
  • Ongoing monitoring
  • Correspondent relationships with related foreign financial institutions.

The obligations under ongoing customer transaction monitoring include the obligation to detect all financial crimes, including market manipulation and insider dealing. Illustrative indicators of suspicious transactions and activities have been included in the guidance, for different types of customer behaviour and different types of transaction, and include selected indicators of market manipulation.

To date, the Hong Kong SFC does not have any published resources to help firms in identifying and mitigating market manipulation, and instead practitioners are reliant on gleaning regulatory expectation from enforcement notices. This is the first time the AML Guideline has been updated to include explicit guidance for firms on how to mitigate market manipulation risks, and should be embraced as a welcome trigger for capital markets firms to update their market manipulation risk assessments and associated toolkits.

The Updated AML Guideline also sets out a new chapter dedicated to the topic of monitoring third-party deposits and payments. There has been a large body of enforcement activity in the broking sector recently on misuse of client accounts to facilitate actual or suspected financial crime. This includes evidence of some particularly egregious behaviours where criminals have been attempting to use loosely controlled broker client accounts as cash banking accounts to launder the proceeds of crime.

The guidance sets out clearer obligations for:

  • Assuming that all third-party deposits and withdrawals are inherently high risk
  • Establishing policy and procedure for control over third-party deposits or payments (i.e. when a person other than the onboarded customer attempts to make deposits or withdrawals from client broker accounts)
  • Bringing in a clearer senior management obligation for oversight over the policies and procedures, and the activity. This includes obligation to designate an MIC of AML/CFT to oversee the proper design and implementation of third-party account activities
  • Guidance on appropriate due diligence processes.

Affected firms, in particular the retail broker community, will need to invest in significantly enhancing their control frameworks in this area.

As for the Fund Managers already mentioned above, the Updated AML Guideline also sets out for the Brokers Illustrative indicators of suspicious transactions and activities, for different types of customer behaviour and different types of transaction. This guidance will be useful for updating training content used for regular AML update training sessions for staff.

Next steps

All firms need to review the Updated AML Guideline in light of the imminent deadlines for implementation of the changes. Firms need to ensure that the changes required to AML policies, and to IRAs and possibly AML training materials are made. We have been helping our clients on this for a number of months, and we have plenty of experience plus a toolkit for completing your IRA, should you need some extra support. Get in touch to discuss.

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