Regulators seek to address “rolling bad apples”, bank culture reform, and cryptocurrency derivatives.

By Farhana Sharmeen, Simon Hawkins, Kenneth Hui, and Marc Tan

This blog post summarises key regulatory developments that took place in Hong Kong and Singapore in May 2020, as regulators in both jurisdictions issued regulatory pronouncements across a spectrum of topics — from the Hong Kong Monetary Authority (HKMA) consulting on proposals to address the so-called “rolling bad apples” phenomenon in the banking sector, to the Monetary Authority of Singapore (MAS) publishing proposals for a regime to regulate certain cryptocurrency derivatives.

Hong Kong: HKMA Proposes Mandatory Reference Checking (MRC) Scheme

On 8 May 2020, the HKMA issued a consultation paper to solicit comments on a proposed MRC scheme designed to address “rolling bad apples” in the banking sector.

A “rolling bad apple” is an individual who engages in misconduct during their employment in a financial institution, and is able to obtain subsequent employment at another institution without disclosing their earlier misconduct to the new employer.

The HKMA’s view is that individuals who are not held accountable for their misconduct at one bank may be more likely to repeat their misconduct at another bank. This may give rise to operational, reputational, financial, and other risks to the new employer who employs the “bad apples”, while also potentially inflicting harm on bank consumers and undermining public confidence in the banking sector.

Having conducted preliminary enquiries with the local banking industry, the HKMA reports that many banks favour the introduction of a MRC scheme.

Under a typical MRC scheme, recruiting banks must obtain a reference from the applicant’s current and former employers using a standard template containing conduct-related information. Current and former employer banks must respond to MRC requests within a specified time period, and all banks are required to have internal controls, policies, and procedures to support the MRC scheme.

Key features of the HKMA’s proposed MRC scheme

  • Scope: The proposed MRC scheme initially would be confined to the local Hong Kong banking sector (i.e., industry-specific and not extra-territorial). A Hong Kong bank that plans to enter into a new employment relationship with a prospective employee (the recruiting bank) would be required to approach all Hong Kong banks that have employed the prospective employee (the reference providing banks) in the preceding 10 years to conduct reference checks in accordance with the proposed MRC scheme.
  • Legal status: Similar to other industry-wide initiatives, such as the issuance of the Code of Banking Practice, the HKMA proposes that the development and implementation of the MRC scheme should be an industry-led initiative endorsed by the HKMA, rather than a formal regulatory requirement imposed by the HKMA through its rule-making powers.
  • Implementation: The HKMA proposes that the MRC scheme will be implemented in two phases:

  • Information to be included in references for the MRC scheme: The HKMA proposes the development of a standard template to collect the relevant information to ensure consistency of MRC information. The contents and format should be agreed by the banking industry, and the HKMA proposes that the template should include the following information:

  • “Look-back” period: The HKMA proposes that the duration of MRC information should cover the prospective employee’s employment records for 10 years preceding the date of application for employment. A bank will need to maintain employment records for former employees for 10 years after the date on which those individuals ceased to be employed by the bank.
  • Response time: The HKMA proposes that reference providing banks be given 10 working days to provide the relevant information to the recruiting bank. If a reference providing bank cannot provide the information within this time period, they should at least provide an interim reply to the recruiting bank explaining why it could not respond to the request within the timeframe, and an estimated timeframe in which a further response can be made.
  • Internal controls: Banks should implement adequate internal systems and controls, policies, and procedures to safeguard the integrity and confidentiality of information obtained and processed during the MRC process.

The consultation on the proposed MRC scheme is open for comments until 7 August 2020.

Hong Kong: HKMA Issues Report on Bank Culture

The HKMA’s bank culture reform agenda was first announced in March 2017, when the HKMA outlined its expectation that banks should adopt a holistic and effective framework for fostering sound culture within their institutions through three pillars:

  1. Governance
  2. Incentive systems
  3. Assessment and feedback mechanisms

In December 2018, the HKMA launched the supervisory measures for bank culture (namely, self-assessment, focused reviews, and culture dialogues) to gauge the progress of bank culture reform in Hong Kong, and, in early 2019, the HKMA required 30 banks (including all major retail banks and selected foreign bank branches with substantial operations in Hong Kong) to conduct self-assessments on their culture enhancement efforts and to benchmark themselves against the findings of major conduct incidents outside Hong Kong.

On 22 May 2020, the HKMA published the Report on Review of Self Assessments on Bank Culture (the Report). The Report sets out common themes and practices the HKMA has observed in its review of the self-assessments from the 30 banks.

Common themes

The HKMA encourages banks to pay attention to certain common themes identified in the Report, including:

  • Incentives: Further work is needed to ensure that banks’ incentive systems promote a sound culture and prevent incidents of misconduct (g., ensuring that remuneration practices are designed to encourage the desired behaviours and focus not only on what the staff do, but also how they do it).
  • Connectivity: Stronger links are required to connect banks’ Hong Kong operations with the culture efforts of their headquarters or upstream entities as well as their downstream operations, as appropriate. The HKMA expects banks to spread their desired culture to their downstream operations outside Hong Kong, taking into account the local circumstances. This is particularly important for larger banks that span numerous geographies and business lines and mayhave a large number of different sub-cultures that have developed over time.
  • International benchmarking: Banks are expected to conduct deeper analysis to benchmark themselves against the findings from reviews of major overseas misconduct incidents (g., the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry in Australia). Banks should understand the underlying root causes of such misconduct incidents and try to identify whether similar incidents could arise in their own institutions (notwithstanding that their business models and product offerings may differ).
  • Professional development: More focus is needed to facilitate the undertaking by relevant staff of the continuous professional development under the Enhanced Competency Framework (a set of common and transparent competency standards for banking industry professionals) or by other professional bodies to complement the effort of promoting sound culture.
  • Creating a secure environment: More work is needed to promote an environment that provides “psychological safety”, to encourage staff to speak up without fear of adverse consequences. Effective “speak up” mechanisms focus heavily on protecting those staff who choose to speak up and recognise the importance of responsiveness, as staff will only feel safe to speak up if their voices will be heard.
  • Fatigue avoidance: Sustained effort is required to drive cultural changes and banks should be mindful of “culture fatigue”. Banks must sustain their current efforts by embedding sound culture awareness at all levels over time.

Next steps

The HKMA will conduct focused reviews to dive deeply into the incentive systems of front offices in the business of distributing banking, investment, and/or insurance products in retail banks.

The HKMA commenced culture dialogues with several banks in 2019, and will continue this engagement in future. Banks will be contacted individually if they are selected to participate in culture dialogues with the HKMA.

The HKMA will continue to work closely with the industry to promote sound bank culture and to gauge the progress of bank culture reform in Hong Kong. The HKMA will also continue to explore other culture initiatives, taking into account overseas experience and emerging themes that may arise.

Singapore: MAS Confirms Regulatory Approach for Derivative Contracts on Payment Tokens

On 15 May 2020, the MAS issued its response to feedback about its proposed regulatory approach for derivative contracts that reference payment tokens as underlying assets (Payment Token Derivatives), confirming that it will regulate Payment Token Derivatives offered to Singapore investors through approved exchanges. The MAS considers it crucial that it has effective oversight of products offered on approved exchanges due to the systemic importance of such trading facilities and the risk of contagion to the wider financial system.

Payment Token Derivatives not offered through approved exchanges (including overseas exchanges) will not be prohibited and will not be regulated by the MAS. The MAS considers this necessary to prevent any misplaced confidence in such highly volatile products that could lead to a wider offering to retail investors.

The above regulatory scope is also reflected in the Securities and Futures (Prescribed Underlying Thing) Regulations 2020, which came into effect on 18 May 2020.

Definition of payment token

A payment token is any digital representation of value that meets all of the following conditions:

  • Is expressed as a unit
  • has a value not permanently fixed by such payment token issuer to one or more currencies
  • Is, or is intended to be, a medium of exchange accepted by the public, or a section of the public, as payment for goods or services or for the discharge of a debt
  • Can be transferred, stored, or traded electronically

Measures for retail investors

In its response, the MAS also reaffirmed its view that Payment Token Derivatives are not suitable for most retail investors and expects the following measures to be in place by 30 June 2020:

  • Requiring MAS-regulated financial institutions to collect from retail investors 1.5 times the standard amount of margin required for Payment Token Derivatives contracts offered by approved exchanges, subject to a floor of 50%
  • Advising retail investors not to trade with unregulated entities, and, if they do so, they forgo the protection provided by regulatory safeguards and trade at their own risk
  • Increasing consumer education efforts (g., via MoneySENSE) to caution investors against the high risks of trading Payment Token Derivatives and dealing with unregulated entities

In accordance with its general stance of not endorsing specific products, the MAS will not publish a list of regulated derivatives of tokens. Instead, interested persons are to assess if their activities fall within regulatory scope and if they are in compliance with regulatory requirements.

Looking ahead

The MAS will continue to monitor industry developments in assessing both the effectiveness of the above measures and the need for further measures in the forms consultation respondents have suggested. The MAS is also expected to issue its response to feedback received on its proposed regulatory approach on the scope of e-money and digital payment tokens, in view of the emerging asset class of “stablecoins”, following a consultation paper published on 23 December 2019.