Hong Kong's Manager in Charge regime: Implications for licensed corporation

Yes Introduction

In December 2016, Hong Kong’s Securities and Futures Commission (the SFC) issued a circular to introduce measures to heighten the accountability of senior management of licensed corporations (the Circular). The Circular tracks a similar measure introduced in the UK in March 2016, the Senior Managers Regime (SMR), and reflects an established global trend towards enhanced scrutiny of individual conduct in regulatory enforcement. The circular became fully operational on 17 October 2017 following a six month transition period. See our previous briefing on the SFC Manager in Charge regime.

In this note we explain the likely implications and conclude with our three key points for licensed corporations.

Implications for licensed corporations

Responding to challenges around employee engagement and training

The key challenges for licensed corporations are likely to be more employee-focused. Licensed corporations may find that they experience different demands during the recruitment process for senior management roles (particularly from potential non-executive directors) about the extent of their exposure. For example potential Managers in Charge (MICs) may request higher compensation packages in response to the heightened risk of enforcement activity, or a right to receive free and independent legal advice during any internal investigations into potential failures in risk management within their reporting lines. Firms should consider whether to extend directors and officers liability insurance coverage to more members of senior management which may address some of these perceived concerns.

With the prospect of enhanced supervision and enforcement activity in mind, licensed corporations should take steps to engage with their current senior management teams to ensure that they understand the scope of their regulatory obligations on an ongoing basis. In particular, senior managers should be trained on how they should respond to material failures in risk management or misconduct which are escalated to them, and specifically what steps they should take to document their decision making and upwards escalation to other senior managers or risk committees. This will be particularly important in the context of remediation exercises, where the committee-based nature of such projects can leave senior managers exposed to criticism should issues not be progressed in a timely way.

The precise scope of senior managers’ responsibilities will inevitably be brought into sharper focus in 2018, and licensed corporations should take the opportunity now to mitigate the risks associated with increased supervisory and enforcement action in this area.

Increase in parallel investigations and enforcement activity in relation to senior management accountability

The Circular heralds a renewed focus by the SFC on individual accountability and its role in setting the culture of licensed corporations. This reflects a well-established global trend in regulatory enforcement, and underscores the SFC’s commitment to ensuring that the "tone from the top" within licensed corporations is appropriate.

The primary long term consequence of the Circular for licensed corporations will be closer scrutiny of individual decision making and judgment. This will be particularly so where material failures of risk management or misconduct are identified within an MIC’s reporting line. In practical terms this will mean that licensed corporations, to the extent they do not already do so, may need to adjust their investigations protocols in order to conduct parallel or consequential factual investigations into individual accountability.

As part of those investigations licensed corporations will need to undertake careful and detailed assessments of the scope of responsibility set out in any information previously provided to the SFC, and to critically assess whether the relevant individuals have discharged their responsibilities appropriately. The SFC will likely wish to see clear evidence that MICs and their senior subordinates have exercised appropriate judgment when presented with difficult facts. In particular the SFC will wish to see how issues have been identified and escalated within their relevant reporting lines and beyond.

The fact that a licensed corporation has carried out such an investigation, together with its findings and the management response in terms of the approach to individual accountability, will likely influence the SFC’s view as to whether enforcement action against the licensed corporation (now or in the future) is necessary to correct any perceived cultural failings. Compliance teams and other relevant control functions should be aware of this new reality. This is particularly so in terms of assessing the need to sanction senior management in light of failures identified during internal investigations, and more specifically, how the failure to sanction such an individual may be interpreted by the SFC in the context of the SFC’s ongoing assessment of the culture of the licensed corporation.

Conclusion and three key points

The Circular underscores the SFC’s focus on culture and senior management conduct. While the SFC has stopped short of seeking to introduce wholesale changes to achieve its objective of linking individual accountability to cultural change, the long term challenges, flowing from increased scrutiny of senior management conduct and ensuring continuing compliance with the Circular are more demanding, and will require ongoing engagement and focus from senior management and compliance as well as from other control functions.

The three key points for licensed corporations to take on board are as follows:

1. Whilst the Circular does not impose any additional civil or criminal liability on senior management of licensed corporations, it clearly sets out the SFC’s current powers to take action in response to individual misconduct. Licensed corporations should consider providing training to their senior management to ensure that they understand the scope of their regulatory obligations on an ongoing basis.

2. Although the substance of the regulatory framework is unchanged, it is clear that the SFC intends to cast a wider net for enforcement in terms of individual accountability than has been the case to date. Arguably this is particularly so for compliance teams, who the SFC has previously considered to be outside the scope of the licensing regime, given their role as an independent control function. All members of senior management of licensed corporations (even if they are not licensed) are regulated persons because of their involvement in the management of the licensed corporation’s business. Their actions, and not only those of the Board, are likely to be subject to heightened regulatory attention. To the extent that licensed corporations do not already review and assess individual accountability in parallel with or as a consequence of internal investigations, they should adjust their internal processes to do so in order that they may respond appropriately to the SFC’s renewed focus on individual accountability.

3. The Circular confirms the SFC’s focus on conduct and culture and clears the path for the SFC to identify and hold to account those individuals who are responsible for material failures in risk management or misconduct.