Oversight January 2017 - Hong Kong's 'Manager-in-Charge' regime

Introduction

In Hong Kong all persons carrying on a business or holding themselves out as such in a regulated activity must be licensed or registered under the Securities and Futures Ordinance (SFO), the overarching legislation which governs, amongst other things, intermediaries in Hong Kong.  Under the licensing regime for non-banks, corporations licensed by the Securities and Futures Commission (SFC) must have not less than two responsible officers (ROs) approved by the SFC who are responsible for the relevant regulated activity.  The SFO prescribes that at least one RO must be a director of the licensed corporation (LC).

However the regulatory regime in Hong Kong extends accountability beyond ROs and other licensed representatives.  Section 194 of the SFO empowers the SFC to discipline any “regulated person” (defined to include persons involved in the management of an LC regardless of whether they are licensed or not) who is guilty of misconduct or not fit and proper.  In addition General Principle 9 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Code of Conduct) states that senior management, which is not defined, should bear primary responsibility for ensuring the maintenance of appropriate standards of conduct and adherence to proper procedures by the LC.

Despite the existing framework, in light of the global trend to make senior management of LCs more accountable, for example the “senior manager” regime in the United Kingdom (SMR), the SFC takes the view that there is a need to delineate who are the senior management of a LC (being a subset of “regulated persons”).  The aim is to better align senior management of LCs with the RO regime and to prompt awareness of senior management as to their regulatory obligations.  Accordingly the SFC issued a Circular on 16 December 2016 setting out specific measures for augmenting the accountability of senior management of LCs (Circular) and an attendant set of frequently asked questions (FAQs).  A further circular was issued on 19 January 2017 notifying LCs of the SFC’s workshops in February and March 2017 to explain the new features of the SFC Online Portal through which LCs will need to submit the required information and organisational charts under the “manager-in-charge” regime.

The main objective of the Circular is to clearly define who the SFC considers to be members of senior management in LCs and to have clearly identified individuals held accountable for regulatory lapses that belong to their area of responsibility.  The idea is that by holding individuals of seniority personally accountable, there will be greater incentive to maintain better systems, controls and corporate cultures in LCs. At first glance the new regime may appear to be an information collection and registration system that does not substantively affect legal obligations and liabilities of senior managers.  However, from a regulatory perspective, the SFC argues that it is not unreasonable to ask LCs to identify who in their corporate or group structures are responsible for which functions.  For many LCs which operate within wider groups, such as Hong Kong operations of London or New York based hedge funds, the regime is a significant change to existing arrangements.

This Oversight article describes the regime set out in the Circular and references the SMR for comparison.  For a summary of the key short, medium and long term risks and implications of the regime for LCs, please see our article Hong Kong’s new approach to individual accountability in regulatory investigations – Implications for licensed corporations. 

The information collection starts for all LCs on 18 April 2017 and reporting deadline is 17 July 2017.  New RO applications (by those non-RO managers with Overall Management Oversight and Key Business Line functions) must be made by 16 October 2017.

The objectives under the New Regime

The Circular states five objectives:

• Identifying who should be regarded as senior managers of LCs
• Promoting awareness of the obligations and potential liabilities which attach to such managers
• Expressing the SFC’s expectation that certain members of senior management should seek the SFC’s approval to be ROs
• Outlining the responsibilities of an LC’s board of directors (Board)
• Providing guidance on the information which an LC should submit to the SFC in respect of its human resources and organisational structure.

While the Circular does not purport to impose any new civil or criminal liability on senior management, it in effect clarifies “senior management” to include persons appointed as “Managers-in-Charge of Core Functions” (MIC), which in turn places both licensed and also unlicensed persons who are appointed as MICs under regulatory scrutiny and possible disciplinary action from the SFC. An explanation of who a MIC is, is provided below.  In brief, a MIC is a person who is responsible for one of the eight newly defined core functions of an LC. Under the new regime, an LC must submit information about each MIC to the SFC.

As described above, senior management of an LC will now formally be interpreted by the SFC to mean not only directors and ROs but also a new group called MICs, who may or may not be licensed individuals. These roles are not mutually exclusive: the same person can be all three simultaneously.  A single MIC can also be in charge of multiple core functions at the same time. 

MICs

MICs are individuals appointed by an LC to be principally or jointly responsible for managing any of the eight defined “core functions” of an LC (Core Functions), as described in Annex 1 of the Circular:

• Overall Management Oversight: A function responsible for directing and overseeing the effective management of the overall operations of the LC on a day-to-day basis; this may typically be the Chief Executive Officer of the LC.
• Key Business Line: A function responsible for directing and overseeing a line of business which comprises one or more types of regulated activities; this may typically be the Chief Investment Officer, or Head of Corporate Finance.
• Operational Control and Review: A function responsible for: (i) establishing and maintaining adequate and effective systems of controls over the LC’s operations and (ii) reviewing the adherence to, and the adequacy and effectiveness of, the LC’s internal control systems; this may typically be the Chief Operating Officer. 
• Risk Management: A function responsible for the identification, assessment, monitoring and reporting of risks arising from the LC’s operations; this may typically be the Chief Risk Officer or Head of Risk Management.
• Finance and Accounting: A function responsible for ensuring the timely and accurate financial reporting and analyses of the operational results and financial positions of the LC; this may typically be the Chief Finance Officer.
• Information Technology: A function responsible for the design, development, operation and maintenance of the computer systems of the LC; this may typically be the Chief Information Officer.
• Compliance: A function responsible for: (i) setting the policies and procedures for adherence to legal and regulatory requirements in the jurisdiction(s) where the LC operates; (ii) monitoring the LC’s compliance with the established policies and procedures; (iii) reporting on compliance matters to the Board and senior management; typically this may be the Chief Compliance Officer or Head of Legal and Compliance. The FAQs also make a distinction between the compliance and legal functions, and only the former (i.e. compliance) falls within the scope of the Core Function. Thus the head of compliance should be appointed as the MIC rather than the general counsel if both positions exist in a firm. However, that does not preclude an in-house counsel from assuming the MIC of Compliance role. But where an in-house counsel assumes the MIC of Compliance role, he must be conscious of his duties as the MIC of Compliance and that the new regime primarily targets the responsibilities under the Compliance Core Function (even if he is responsible for other responsibilities as general counsel in parallel). 
• Anti-Money Laundering and Counter-Terrorist Financing: A function responsible for establishing and maintaining internal control procedures to safeguard the LC against involvement in money laundering activities or terrorist financing; this may typically be the Head of Financial Crime Prevention or the Head of Compliance.

Depending on the size of the LC and the scale of its business, a Core Function may be managed jointly by more than one MIC, or, conversely, a single MIC may manage more than one function, or one MIC may be appointed to manage each Core Function.

The SFC also provides guidance on which individuals may be suitable to be appointed as MICs. Consideration is given to both the individual’s actual and apparent authority and his or her seniority.

In terms of authority, the person should (i) occupy a position which gives him or her significant influence on the conduct of the relevant Core Function, (ii) have authority to make decisions for that Core Function, (iii) have authority to allocate resources or incur expenditure for the particular department, division, or functional unit responsible for the relevant Core Function, and (iv) have authority to represent that particular department both internally and externally. In respect of seniority, the proposed MIC should be able to report directly to the Board (or to the MIC who is responsible for the Overall Management Oversight function) and he should be directly accountable to the Board (or the MIC responsible for Overall Management Oversight for the achievement of business objectives). In addition, they may also report directly to the parent company and/or to senior management personnel of their group in accordance with the policies and procedures of the group.  

A welcome aspect of the regime is that the SFC does not require MICs to seek regulatory approval to be an MIC (though the case is different where the MIC is also an RO and is therefore a licensed person). 

The Circular also makes it clear that, after appointment, the MIC must also acknowledge and accept his or her appointment as a MIC with regard to the Core Function for which he or she is responsible.

Although MICs need not be actual employees of the LC, they cannot be external parties undertaking outsourced work. Depending on the function MICs perform in the LC, they may or may not be licensed under the SFO, although this does not affect their susceptibility to SFC disciplinary action (under the SFO). 

It is important to note that MICs may be located either in Hong Kong or overseas. For large asset management companies headquartered overseas and with complex organisational arrangements, the identification of MICs may be challenging.  For MICs located overseas and who, in the group corporate chain, may be one of the most senior members of group management, it will be interesting to see how the SFC’s expectation for them to report directly to the Board (or to the MIC who is responsible for the Overall Management Oversight function – likely the head of the Hong Kong office) will work in practice. 

MICs who must be ROs

The SFC expects that a MIC responsible for the Overall Management Oversight and Key Business Line Core Functions should also be an RO in respect of the regulated activity that individual oversees. While it is relatively clear which regulated activity or activities in respect of which a Key Business Line MIC (such as a Chief Investment Officer of Head of Corporate Finance) should be approved as an RO, it is less clear for the MIC responsible for Overall Management Oversight (such as a Chief Executive Officer). The FAQs state that although the MIC responsible for Overall Management Oversight is expected to be an RO in respect of all the regulated activities that the LC is licensed to do, because he or she would be involved in the day-to-day operations of such activities, there could be exceptions in cases where such a MIC is only responsible for certain, rather than all, regulated activities of the LC. Where this is the case, the SFC expects the management structure document (see below) to clearly set out each MIC’s responsibilities, especially where the MIC assumes responsibility for only part of the Core Function.

Standard of Conduct

The SFC states in the Circular that the standard of conduct expected of senior managers should not be considered to have changed. It continues to involve high-level supervision and the ongoing maintenance of proper systems and controls. 

• General Principle 9 of the Code of Conduct states that a senior manager of an LC is primarily responsible for the maintenance of standards of conduct and adherence to proper procedures by the LC.
• Paragraph 14.1 of the Code of Conduct states that senior management of an LC should
  • manage risks in the business of the LC, including performing periodic evaluation of its risk management processes
  • understand the nature of the business of the corporation, its internal control procedures, and its policies on the assumption of risk, and 
  • understand the extent of their own authority and responsibilities.  
• The SFC’s Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the Securities and Futures Commission states that senior managers are ultimately responsible for the adequacy and effectiveness of the corporation's internal control systems.
• The SFC’s Guideline on Anti-Money Laundering and Counter-Terrorist Financing sets out expectations regarding compliance and control functions relevant to MICs responsible for managing the Anti-Money Laundering and Counter-Terrorist Financing function.

Legal Liabilities

The reason the Circular declares that the new measures are consistent and within existing law and regulation is because the SFO already permits disciplinary action to be taken against “regulated persons”, who may well be unlicensed individuals (such as an unlicensed MIC).  This is the basis of the SFC’s decision not to issue a new code or formal guideline or to revise existing rules such as the Code of Conduct without undertaking a full public consultation.

Under Part IX of the SFO, the SFC may sanction a regulated person if the person is guilty of misconduct or is not considered fit and proper to be or remain the same type of regulated person. The term “regulated person” refers to: (a) a licensed person; (b) an RO; or (c) a person involved in the management of the business of an LC (regardless of whether or not he or she is licensed). The Circular then states that all members of the senior management of an LC are regulated persons for this purpose, because of their involvement in the management of the LC. Therefore, all MICs, licensed or otherwise, are potentially liable to SFC disciplinary action because they are all considered to be regulated persons under the SFO.  Whether or not this interpretation will stand in any action before the courts remains to be seen.  Ultimately the SFC’s power derives from the SFO, not the Circular, and only a court can determine who is a regulated person.

The SFC may take action to sanction an individual guilty of misconduct, or because he or she is considered no longer fit and proper under section 194 of the SFO. In respect of the former, if an LC is guilty of misconduct which has been committed with the consent, connivance, or is attributable to the neglect of a person involved of the management of the LC (e.g. a MIC or senior manager), the individual is also personally liable under section 193(2) of the SFO. In respect of the latter, the SFC can sanction a regulated person no longer deemed fit or proper, and in their assessment of fitness and properness, the SFC will consider past or present conduct of that person.

When deciding whether or not to sanction senior managers, the SFC has to determine where responsibility lies, and the degree of responsibility of a particular member of senior management. To do so, the SFC will consider the individual’s apparent or actual authority, his or her level of responsibility within the LC, any supervisory duties he or she may perform, and the level of control or knowledge he or she may have concerning any failure by the LC or persons under his or her supervision to observe the Code of Conduct. 

The disciplinary actions which the SFC may impose on a regulated person under Part IX of the SFO are civil, such as license revocation or fines. There may also be criminal liability. Where the LC is found guilty of a criminal offence under the SFO, an officer of the LC, such as an MIC, may be found guilty under accessory liability.  In the context of the foregoing it is noteworthy that a MIC must, as mentioned above, acknowledge and accept his or her appointment.  

Board Responsibility 

Reaffirming general principles on directors’ duties, the SFC states that the Board has ultimate responsibility for the conduct of the LC.  The SFC further says that senior management is accountable to the Board. The SFC states that directors, whether executive or non-executive, have a duty to exercise independent judgment in the exercise and delegation of the Board’s powers. It is again worth noting that the SFC requires all “executive directors” of LCs to be licensed as ROs.  “Executive director” is defined in section 113 of the SFO to mean a director of an LC who actively participates in, or is responsible for directly supervising, the business of a regulated activity for which the LC is licensed.  If directors delegate their functions, they remain responsible for delegated decisions and should instate systems and controls to supervise those who act on delegated authority. 

Importantly, going forward, the SFC requires that an LC should adopt a formal document, approved by the Board, clearly setting out the management structure of the LC, including the roles, responsibilities, accountability, and reporting lines of its senior management personnel.  Where an LC designates more than one individual to be the MICs of a particular Core Function, the Board should ensure that the document clearly sets out the specific responsibilities of each MIC concerned.  The SFC may request an LC to provide the document for its review.  

Separately, certain key information regarding an LC’s management structure should be submitted to the SFC, as explained below.  It is likely to be one of the many documents the SFC routinely requests in advance of an audit by the SFC of the LC.

Management Structure Information

The present requirement is that when a corporation applies for a license under section 116(1) of the SFO, it has to provide information about its human resources and organisational structure to demonstrate that it can carry on regulated activities competently. Going forward, the SFC expects an applicant corporation to provide information regarding its MICs and its organisational chart in its application. 

In respect of its MICs, the corporation now needs to submit the following particulars:

• full name
• identification information
• job title
• place of residence
• the Core Function(s) of which he or she is in charge, and
• the job title(s) of the person(s) to whom he or she reports within the corporation or within the corporate group.

To assist companies in submitting MIC information, the SFC will publish a new standard form entitled “Supplement 8A – Manager-In-Charge of Core Function(s)”, a draft of which can be found in Annex 2 of the Circular. 

The organisational chart should depict the LC’s management and governance structure, business and operational units, and key human resources and their respective reporting lines. It should also specify all MICs, their respective reporting lines, and the job titles of the persons reporting directly to them. To assist companies in submitting such information, the SFC will revise its standard form entitled “Supplement 8 – Business Plan and Proposed Business Activities”. 

An LC should also notify the SFC of any changes in its appointment of MICs or any changes in the particulars of its MICs within 7 business days.  This is no different from the obligation on an LC or substantial shareholder of an LC to notify the SFC of changes in most relevant information.  Where the change involves a new appointment or cessation of appointment, or a change in the particulars referred to above (i.e. change in the Core Function for which the MIC is responsible or the job title(s) of the person(s) to whom the MIC reports to), the LC should also submit an updated organisational chart in its notification of the change. 

Upon implementation of the measures on 18 April 2017, and on or before the deadline of 17 July 2017, LCs or applicant corporations must submit the MIC information and organisational charts to the SFC via the SFC Online Portal. Any notification of subsequent changes must also be submitted through the Portal.  The LC, rather than the MIC, is responsible for submitting the MIC information to the SFC.     

Timing

As mentioned above, the information collection initiative will commence on 18 April 2017, and information so required should be submitted on or before 17 July 2017 via the SFC Online Portal.

Accordingly, LCs should begin any necessary preparatory work to appoint MICs and compose the necessary documents for submission soon.  Further, MICs of the Overall Management Oversight and Key Business Line Core Functions must apply for approval to become ROs on or before 16 October 2017.

SMR

The MIC regime comes in the wake of the SMR, which took effect on 07 March 2016, although by comparison the SMR is much more extensive and onerous. 

The SMR is part of a 3-part regime, comprising the SMR itself, a certification regime, and an enhanced set of conduct rules. 

• The SMR is the regime to which the MIC regime most resembles. Under the SMR, senior managers are defined as individuals who perform senior management functions (SMFs) as specified by the United Kingdom’s Prudential Regulation Authority (PRA) and Financial Conduct Authority (FCA), the equivalent of Core Functions in Hong Kong. Senior managers are required to seek approval from regulators to perform SMFs. They are required to attach to their application a “statement of responsibilities” setting out the areas for which they are personally accountable, not unlike the SFC’s proposed Supplement 8A, and the corporation must also produce a “firm responsibilities map” which details clearly the firm’s governance structure and personnel arrangement, also not unlike the SFC’s to-be revised Supplement 8. And, similar to the Hong Kong regime, a senior manager will be accountable for regulatory lapses by the firm in the particular area of activity for which he or she is stated to be responsible, and thus amenable to disciplinary action. Senior managers can look to new conduct rules for guidance on their expected behaviour, which has a section that applies specifically to senior managers. However, the new regime also attaches criminal liability to a senior manager who recklessly causes the financial institution to become insolvent. 
• The certification regime has no parallel in the Hong Kong system at the moment. It applies to individuals who do not execute SMFs but are nevertheless deemed to have enough authority to cause significant harm to the firm or its customers. They are said to perform “significant harm functions”. Unlike senior managers, these persons need not be approved by the FCA or PRA but instead are certified by the firm itself as being “fit and proper” on an annual basis. Senior managers will be responsible for ensuring that the annual internal certification process is of an acceptable standard.
• Finally, the new conduct rules lay out general obligations that apply to all employees in such regulated corporations, with the exception of ancillary staff such as security guards or IT technicians.  These conduct rules are meant to be of wide application and mark the first time many personnel are subject to direct regulatory oversight and possible personal liability. 

The changes made in the United Kingdom go much further than the new regime in Hong Kong. The certification regime and enhanced conduct rules catch a far broader range of personnel working in financial institutions beyond senior managers. Although the SMR is arguably similar to the MIC regime, the SMR is arguably more robust as it requires senior managers to seek regulatory approval prior to taking up the post overseeing a SMF.  In addition a senior manager under SMR may also attract potential criminal liability for recklessly causing a corporation to fail. The documentation requirements (statement of responsibilities and the responsibilities map) are also considerably more detailed than their Hong Kong counterparts.

Whether or not Hong Kong will follow the United Kingdom and adopt something similar to the certification regime and rules akin to the conduct rules remains to be seen.

Conclusion

LCs have limited time to meet the obligations under this SFC initiative. Steps should be taken promptly to identify individuals to assume the position of MIC over Core Functions. They must fully understand their responsibilities and their amenability to SFC disciplinary action. Persons appointed to be MICs should also acknowledge and accept their new role. The relevant documents should be filed once the SFC releases the revised Supplement 8 and new Supplement 8A.  International financial groups with Hong Kong operations, such as fund managers, will need to consider reporting lines and the composition of the Boards of their LCs.

LCs should take care in nominating MICs. They should make sure MICs fit the suitability criteria, in that appointees must have the requisite level of authority and seniority within the LC, especially in large organisations. LCs should also consider if it is appropriate to divide responsibility over a Core Function among multiple MICs, and, if so, to clearly delineate the responsibilities of each MIC. 

The Circular asserts that the MIC regime does not change the duties and liabilities of senior managers, and is in line with existing law. While the new regime does not technically increase the obligations or make more onerous the standard of conduct expected of senior managers under the SFO (for which the legislation would require amendment), it places great emphasis on individual accountability and is a clear statement of the SFC’s regulatory intent.  It is clear that identified senior managers can expect to be held personally responsible by the SFC for misconduct that falls within their purview. It is no secret that the objective is to incentivise senior managers to monitor he controls, systems and culture within an LC. It remains open to question whether this marks a substantive change in the SFC’s regulatory approach, or is more of an awareness-raising reiteration of existing accountability principles.  It will also be interesting if in future an unlicensed MIC challenges the SFC’s disciplinary actions in the courts.

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