Hong Kong’s securities regulator is turning its focus to professionalism, corporate culture and ethics as part of a more principles-based and forward-looking approach to supervising market participants.
Prudential and market structure regulatory responses to the global financial crisis have not restored trust, said James Shipton, executive director of the Securities and Futures Commission’s (SFC) intermediaries division.
Although regulators have tackled capital requirements and introduced counter-party and market sector regulation, including OTC derivatives rules, deep-seated ethical and cultural failings continue, he noted at an event hosted by the Hong Kong Investment Funds Association yesterday.
“We will broaden our supervisory approach, so when we look at control systems and control procedures at firms, we will also consider the control culture and the leadership dimension of a firm to more fully understand how its control systems operate in practice,” he said.
The regulator’s new strategy comprises three elements: incentivising ethical behaviour; examining leadership and decision-making structures; and assessing corporate values and professionalism.
“What has been missing in the responses to the financial crisis is consideration of the human element,” Shipton said. “That is, how human decisions and behavioural considerations caused the crisis and the front-page conduct issues we have seen since then.”
Because decisions originate with individuals and are shaped by firms’ decision-making processes, the regulator will turn its attention to incentives that promote ethical behaviour. Shipton argued that there had been an over-reliance on disincentivising poor behaviour.
“Punishment and deterrents will only ever go so far,” said Shipton (pictured). “The proverbial stick needs to be combined with the carrot. Here the industry needs to lead the way, and further enhance its incentive structures, so that the right decisions and ethical conduct are incentivised.”
Preventing problems from arising is more cost-effective than penalising transgressions, he added.
Shipton identified senior vice-presidents and junior managing directors as an important stratum of leadership that could promote ethical conduct and enshrine values in corporate culture.
To implement its new strategy, the regulator will increase direct communication with senior leaders of firms, and move away from relying on interacting with compliance and legal departments.
Risk and control processes will be a major regulatory focus, Shipton said. He called for industry-led initiatives to create a market eco-system that encompasses a self-reinforcing culture of high standards.
“Firms do not expect a high enough standard of each other,” he noted. “Each firm appears reluctant to express, let alone require, the best standards of its counterparties.”
He also called for firms that transgress industry standards to be ostracised.
As many of Hong Kong’s market participants are headquartered abroad, with some compliance and control functions located outside the city, the SFC said it would pay more attention to incidents that occur beyond its jurisdiction.
“We will keep in mind events and developments happening to a firm outside Hong Kong as these are likely key indicators of control and compliance for its operations in Hong Kong,” Shipton added. “We will look at the sum of the parts.”
As well as looking to firms’ activities abroad, Shipton said the SFC would work on increasing cooperation with other regulators to improve consistency of standards.
“The words ethics, integrity and professionalism have been missing from our industry’s daily discourse for too long. An important part of my job is to bring them back into conversation and back into vogue here in Hong Kong,” said Shipton, who before joining the SFC last June worked at Goldman Sachs as head of government and regulatory affairs for Asia Pacific.