Hong Kong ABC Bank’s Supervisory Policy Manual Report

Executive Summary

The report was prepared for the new Chairman of Hong Kong ABC Bank to understand the current Supervisory Policy Manual relating to money laundering. Broadly, it shows that the Hong Kong financial sector is challenging but promising. Regulatory hurdles continue to increase as regulators become more stringent. With regard to money laundering, the report shows that the regulating body is now more focused on assessing the effectiveness of its regulations. As such, the Bank was penalized for failure to comply with some of the AMLO requirements. Recommendations are provided to improve upon current practices and procedures on money laundering and terrorist financing.

The Supervisory Policy Manual: Money Laundering

This report presented to the new Chairman of Hong Kong ABC Bank covers money laundering as a recent development in the local regulatory requirements found in the Supervisory Policy Manual. The report covers specific areas that Hong Kong ABC Bank has not been able to comply with some of the regulatory requirements, leading to a massive fine in the last fiscal year.

Anti-money laundering has been a major focus for financial institutions and their regulators globally. In Hong Kong, too, the regulator – Hong Kong Monetary Authority (HKMA), financial institutions, and citizens have advocated for more strict anti-money laundering procedures to deter banks from such practices. Lately, terrorist financing has also been classified with anti-money laundering because they rely on similar practices and channels. With the increased regulatory environment around anti-money laundering, financial institutions in Hong Kong now face huge penalties for non-compliance, risk reputational damage, and potential criminal charges.

Hong Kong Banking Sector: Overview

The KPMG report for the fiscal year 2015 shows that it was a tough year for Hong Kong’s banking sector. It was characterized by several challenges, including increasing costs, loan growth, increasing bad loans, and squeezed margins. Notwithstanding the previous year’s growth, the sector recorded abysmal growth in assets at about 2%, which was extremely low compared to the previous growth of 8% in each of the prior two years. Without considering a substantial gain of HK$11 billion realized by Hang Seng Bank Limited, the overall profitability of the sector declined by 1% (KPMG 2).

The survey further revealed that banks were under intense pressure from revenues and increasing credit costs to normal rates. By considering both pressure on the revenue and the possibility of ‘lower for longer’ interest rate for the sector, cost now is the only major factor that determines profitability. Nevertheless, it is expected that the fiscal year 2016 and beyond may bring new opportunities. The most vital question is whether potential opportunities may outweigh the noted threats. Hong Kong being an international financial hub, uncertainties in the global economy, significantly influences its banking sector. The current financial year is also characterized by uncertainties attributed to the global economy. The US Presidential Elections, the Brexit, and unpredictable China’s economic growth, for instance, could affect the outcomes of the year.

Amidst pressure on revenues and intense competition, Hong Kong banks now focus on new methods to drive profitability. Some banks have focused on improving customer experience through service offers, mobile, and Internet banking, and other payment options to facilitate revenue generation. Still, others may concentrate on optimal cost management, enhancing regulatory reporting, and relying on data for insights. Additionally, other banks have turned to FinTech for profitability to exploit new opportunities that emanate from technologies and innovation in the banking sector (Maltem Consulting Group 1-7). The KPMG report also indicates that Hong Kong banks have changed their thinking and attitudes toward FinTech, and they now increasingly consider FinTech as complementary instead of a direct competition against their established traditional business practices.

At the same time, financial institutions in Hong Kong continue to face many regulatory issues. In the near future, for instance, regulators are most likely to introduce more new rules and initiatives to drive Basel III, anti-money laundering, e-banking, cybersecurity, Foreign Account Tax Compliance Act (FATCA), Common Reporting Standard (CRS) and stored value facilities among others. In addition, it is expected that the Non-Performing-Loan (NPL) in China will possibly influence banks in Hong Kong and, therefore, it is necessary for Hong Kong banks to assess and revamp their risk management framework. While some of these hurdles will persist, financial institutions in Hong Kong can still grow their revenues and profits. For instance, banks that are agile, innovative, focused, and apply technology and data analytics will definitely grow their revenues and profits.

On this note, the Hong Kong Monetary Authority (HKMA), which is the government authority in Hong Kong responsible for maintaining monetary and banking stability, has observed that the sector should expect increased uncertainty in the macroeconomic environment (Hong Kong Monetary Authority 4-6). The market is fragile and jittery, and any trivial indicators of trouble could result in stronger activities. Nevertheless, HKMA remains optimistic about future performances.

The Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance (AMLO): A Brief Overview

The often ignored but critical aspects of AMLO are defined in section five. For any financial institution, a criminal offense occurs when:

1. Knowingly violates a defined provision (the penalty is a fine not exceeding HK$1 million and imprisonment for two years)
2. Acting with the intent to defraud a relevant authority (the penalty is a fine not exceeding HK$1 million fine and imprisonment for 7 years)

AMLO also applies to individuals. Therefore, it is a criminal offense if an employee of a financial institution:

1. Knowingly allows or causes a financial institution to violate a given provision. Penalties apply to such violations (HK$1 million and imprisonment for two years). The accused can defend themselves by proving that they acted within the stipulated policies and procedures recognized and implemented by the financial institution.
2. Acts with the intent to defraud a financial institution or any other relevant bodies, allows or causes a financial institution to disregard the provisions of AMLO. This offence attracts a fine of HK$1 million and a possible seven-year jail term.

Based on the definition provided by AMLO, money laundering is a planned act to have the consequence of making any property or proceeds acquired through illegal means to appear as ‘clean’. In this case, different methods are applied, including changing identity of sources of proceeds of crimes to mask their illegal sources and make them appear genuine (Hong Kong Institute of Certified Public Accountants 7-16). In essence, one may violate the law of money laundering when they conduct transactions involving property in cases in which they know that the property is linked to proceeds of crime, or has rational grounds to believe that the property indeed represents proceeds from crime without any doubts even to other external parties.

AMLO also defines terrorist financing as fiscal support rendered to terrorism or engagement, planning, and/or encouraging terrorism. Terrorists and their organizations need fiscal support to attain their destructive aims. Terrorist financing includes acts of financial transactions that involve money owned by terrorists, or which have been, or are planned to be used for conducting terrorism. Terrorists have a tendency to obscure or mask their sources of funds and connections between them and funds. As such, terrorists are always seeking for opportunities to launder money, irrespective of their sources, illegal or legal, to avoid attracting attention and authorities.

Terrorist financing and money laundering apply the same tactics that involve obscuring and disguising funds and their sources. Money launders use legal channels to ‘clean’ their proceeds of crimes while terrorists use the same channels to transfer money, which could be illegal or legal, to mask their sources and final use. AMLO focuses on the provision or collection of any property either directly or indirectly to support acts of terrorism. Thus, acts of terrorism and terrorist associate must be deterred using provisions of laws and regulations.

The Financial Action Task Force (FATF), as a global inter-governmental body has provided specific standards for anti-money laundering. The FATF has provided the ‘Rs’ as a framework for detecting and preventing money laundering and terrorist financing practices. These Rs are vital in combating terrorist financing and money laundering. They provide the legal basis or a reference for most jurisdictions globally. Hong Kong also uses Rs to account for suspicious transaction reporting, customer due diligence (CDD), and record keeping. The Rs extend beyond financial institutions to account for other specified bodies identified as ‘Designated Non-financial Businesses and Professions (‘DNFPBs’), such as accountants.

In Hong Kong, legislation applies to suspicion transactions, disclosure of suspicion transactions, customer due diligence, record keeping, and professional conducts, which are components of the Rs. No institutions or persons are exempted from these laws in deterring money laundering and terrorist financing.

Against these developments in money laundering and terrorist financing, Hong Kong has focused on assessing and implementing its current practices and procedures to ensure that they comply with the Rs based on the provisions that guide CDD, record keeping, and suspicious transactions as applicable to banks and other financial institutions. The regulatory environment will become more stringent as more rules are expected to be enacted.

Powers of HKMA on Money Laundering

The HKMA has wide investigative powers as required under the AMLO. The Authority can gain access to any financial institutions, assess practices, and carry copies of the relevant documents for further scrutiny against the provisions of the law. Moreover, any financial institutions are obligated to produce all the required documents to the Authority within stipulated time and place. Financial institutions may also be asked to attend interviews and respond to raised issues related to an investigation. It is, therefore, a crime for any financial institution or its representatives to fail to comply with requests of HKMA without any rational excuse. The Authority cannot excuse any person for not complying with its requirements, unless the action may incriminate the person. Any responses that are required, but can incriminate the respondent are not considered once the person has made claims before responding. In such circumstances, the responses are not admissible as evidence.

The Authority has power to take disciplinary actions against a financial institution as defined under the law. These disciplinary actions may include public reprimand, pecuniary penalty as defined to the maximum levels (a fine not exceeding HK$10 million or three times the profit acquired or costs avoided), or remedial actions. The Authority, however, must provide an opportunity for a financial institution to be heard before any disciplinary action can be taken against it. The Guideline issued on 2012 continues to define specific factors for consideration when determining fines to be imposed and their limits.

Hong Kong ABC Bank Penalized

In this fiscal year, the Authority took a disciplinary action against Hong Kong ABC Bank under the provisions of AMLO Cap. 615. Hong Kong ABC Bank was the first case to be made public since the law came into effect on 2012.

The Authority instructed Hong Kong ABC Bank to provide a detailed report done by external auditors evaluating the adequacy and efficacy of a counteractive plan prepared and implemented by the Bank. Hong Kong ABC Bank was penalized HK$3.2 million and public reproached for ineffective practices. In short, the Authority established that Hong Kong ABC Bank had violated some stated provisions of the AMLO. The Bank did not:

1. Take initiatives to identify or authenticate identities of some account holders and beneficial owners attached to some corporations during the account-opening period (it violated section 3-1)
2. Ascertain some complex transactions involving extraordinarily some large amounts or unfamiliar patterns of transactions because of depending on automated system reports, which were ineffectual (breached section 5-1)
3. Apprise or evaluate regularly or appropriately risks and rating of the customers in relation to money laundering and terrorist financing (breached section 5-1)
4. Ascertain whether the involved customers were politically exposed individuals (breached section 19-1)
5. Develop sufficient procedures for some vital anti-money laundering or Counter-Terrorist Financing measures – the Bank’s policies and procedures were considered as copies of some provisions provided by the Authority (violated section 19-3) (Securities and Futures Commission 24-113)

These findings demonstrate that Hong Kong ABC Bank did not sufficiently conduct a series of requirements related to anti-money laundering assessment, specifically due diligence on corporate customers, evaluating existing customer relations and transaction patterns, and determining if customers were politically exposed individuals. Apart from the fine, Hong Kong ABC Bank was also ordered to provide an independent report to the Authority, specifying the remedial action it would take to address regulatory requirements.

Recommendations or Remedial Actions

1. The Bank will develop a Competency Framework to improve capabilities of its employees handling customers’ relationships, account opening processes, transaction assessment, and customer due diligence for anti-money laundering and terrorist financing. The Bank understands the issue of talent shortage and the scramble for anti-money laundering professionals as various institutions seek to revamp their compliance team. It is believed that a Competency Framework that is more thorough would assist the Bank to address its human resource needs through training and skills acquisition. The Bank plans to use a similar framework and approach to develop all its compliance officers.
2. The Bank has acknowledged that an ineffective IT system contributed to its failure to comply with the regulations. As such, the Bank intends to embrace new technology solutions to enhance efficiency and cut costs associated with regulatory compliance, specifically when more regulations and enhanced scrutiny are planned for the sector. Precisely, the Bank will embrace technologies that would monitor, flag and improve transaction patterns. These processes will be extensive and, therefore, an effective automated system will be necessary.
3. Further, the Bank plans to refresh its ‘Know Your Customer’ (KYC) and Customer Due Diligence to improve the quality of captured data and consequently, improve standards of compliance.
4. The Bank will also adopt robust technologies to assist in managing distrustful activities, and it may outsource non-core functions to third parties with the aim of improving compliance and efficiency.
5. The Bank has acknowledged that the Authority has enhanced its enforcement practices, and these processes will be extensive and, therefore, an automated system will be necessary.
6. The coming years are most likely to be stringent in terms of regulation as the Authority may revise some provisions in the AMLO. This implies that the Bank should plan to review its current internal risk assessment strategies to increase risk awareness, specifically on anti-money laundering and terrorist financing.
7. The Bank plans to have a more robust and thorough risk assessment plan to account for other challenges, including tax evasion.
8. Given that the Bank’s senior executives are answerable to the Authority, senior executives and the management team intend to spearhead all compliance efforts in the Bank. In fact, the Bank will address the issue of resource allocation with the board to ensure that it can effectively meet compliance standards and regulations.

With these remedial actions, Hong Kong ABC Bank strives to enhance efficiency and optimize money laundering and terrorist financing prevention across all its branches. It is imperative to recognize that the Bank utterly supports the Authority’s initiatives and execution of the law to ensure exceptional standards of compliance and monitoring in the sector. As such, the Bank has undertaken extremely positive and thorough reviews to address its areas of weaknesses based on the above-mentioned recommendations, and the new policies and procedures would ultimately lead to enhanced compliance.

Further, Hong Kong’s financial sector must now acknowledge that the Authority has increased its efforts to monitor the sector on money laundering and terrorist financing after some global watchdogs claimed that it was not effective in its application of the law. More importantly, the Financial Action Task Force (FATF) is scheduled to visit Hong Kong for assessment of its practices. This implies that banks must now conform to AMLO. Additionally, the FATF no longer focuses on the design of anti-money laundering laws in Hong Kong, but now wants to assess the effectiveness of the implemented laws. It is expected that the Authority will issue additional materials to assist the financial sector to ensure compliance with many overlapping regulations. In the immediate future, financial institutions, therefore, should expect more developments related to enforcement of various regulations (Sia Partners 1-10).

Conclusion

The report has covered the most important aspect of the Supervisory Policy Manual, which is money laundering. The overall sector remains promising, but uncertainties persist. The Bank welcomes the disciplinary action adopted by the Authority because it ensures that financial institutions have adequate policies, procedures, and other internal measures to deter money laundering and terrorist financing. The Bank, therefore, will focus on enhanced customer due diligence, reviewing of existing customers, and assessing questionable transactions. It will ensure that all these requirements are effective and sufficiently implemented.

Works Cited

Hong Kong Institute of Certified Public Accountants. “Requirements on Anti-Money Laundering, Counter-Terrorist Financing and Related Matters.” Anti-Money Laundering Bulletin, 2015. Web.

Hong Kong Monetary Authority.2015 Annual Report. 2015. Web.

KPMG. Hong Kong Banking Survey. 2016. Web.

Maltem Consulting Group. FinTech Regulatory Environment in Hong Kong and Beyond. 2016. Web.

Securities and Futures Commission. Guideline on Anti-Money Laundering and Counter-Terrorist Financing. 2012. Web.

Sia Partners. Hong Kong Regulatory Overview and Update. 2014. Web.