UNDERSTANDINGDIVERSITYASIA’S PLACE IN THE GLOBAL REGULATORY FRAMEWORK

Asia is firmly established as the world’s economic powerhouse1. The region boasts long-term growth potential, favourable demographics in the form of a young burgeoning population2, along with a rising middle class that is spending more money on consumer goods. No wonder that a broader range of Asia markets are appearing on the radar of international investors.

However, when it comes to the practical realities of investing in the region, Asia is far from homogeneous. Every market has its own regulations and infrastructure, which means the trading and post-trade processes that apply on one exchange can be very different from another.

To further complicate the situation, the region’s markets are developing rapidly, leading to a regulatory environment that is in constant flux. Investors are therefore not only required to learn the diverse structures of a large number of markets, but also monitor the developments that could impact their business.

The fragmented nature of the Asian market landscape sits uneasily with a growing demand for uniformity from the global investment community, as the financial sector in the US and Europe is subject to a wide range of regulations that influences their behaviour both at home and abroad. Since the US and Europe accounts for around two thirds of global portfolio flows, regional regulations can have a global impact. Asia is not left unaffected.

The result is that global investors – including asset managers, pension funds, and insurance companies – can be discontent with a number of issues that they encounter in Asia. Even the sell side, comprising mainly of intermediaries and investment banks, is grappling with some of these changes in an era where its earnings and appetite to invest has reduced significantly. The specific challenges include differing levels of market access, requirements for information, and asset segregation. There is also a demand for more services from Central Securities Depositories (CSDs).

At HSBC Securities Services, we believe that an important part of our job is to help our partners navigate Asia’s complex regulatory and infrastructure conundrum to ensure that they are always aware of upcoming events that could have an impact on their operations, and at the same time make sure that they do not miss out on attractive business opportunities. In what follows, we have broken this issue into five key topics. By combining the theoretical debate with examples of practical application, we are able to highlight the issues that we believe matter most to investors.

INTRODUCTION

Notes:1. https://www.imf.org/en/News/Articles/2015/09/28/04/53/sp031216, http://www.wsj.com/articles/global-economy-week-ahead-gdp-data-in-japan-and-europe-china-production-14790672002. http://www.unfpa.org/sites/default/files/resource-pdf/SWOP%202014%20fact%20sheet%20-%20Youth%20in%20ASIA.pdf

In order to attract global portfolio flows, markets need to provide easy market access. Exchanges and depositories therefore have to offer a streamlined investor registration process in the face of regulator demands for transparency and Know Your Customer standards. The requirements for market access can be high, with around one third of Asian markets still insisting on investor ID disclosure and the compulsory segregation of accounts. Beyond opening an account, the investment process itself should be seamless in a way that creates a level playing field for both foreign and local investors.

Market access however, is an area where we see real progress in Asia. With the regulatory disparity across markets, there is no common regional approach, but on a place-by-place basis we see individual exchanges taking concrete steps to make the registration process more efficient.

MARKET ACCESS STREAMLINED MARKET ENTRY AND ACCOUNT OPENING

Hong Kong – Stock Connect

PreviouslyWhile the Shanghai-Hong Kong Stock Connect programme allows international institutional investors an easy way to access the A share market in Shanghai, the scheme had a number of issues that made some categories of institutional investors cautious about participating – these included such pre-delivery of securities, the different settlement cycles for securities versus cash, and asset safety risks.

ImprovementsWith the introduction of the new special segregated account structure (SPSA) and with new flexibility offered through same day liquidity for cash settlements, the regulators and exchanges have demonstrated a strong willingness to make the market more conducive to institutional investments. Further announcements have been made around the abolishment of the market-wide quota, while the launch of the Shenzhen-Hong Kong Stock Connect will help add more confidence into the markets from a market access perspective.

India

PreviouslyWhile the Foreign Portfolio Investor (FPI) regime helped to streamline the market entry channels, the documentation requirements for foreign institutional investors also evolved. Initially, an FPI application on an average used to take at least two weeks, delaying the subsequent account opening process.

ImprovementsThe government has recently announced a paperless application system that speeds up the process enormously. Requiring only a digital signature, a PAN will be issued in just one day.

Vietnam

PreviouslyUp until 2015, foreign investors were required to apply for Securities Trading Codes (STCs), a lengthy process that required documents to be translated into Vietnamese and consularized. The approval would take five days after the Vietnam Securities Depository (VSD) received a hard copy of the application.

ImprovementsIn 2016, the VSD launched a new system that allows foreign investors to make an online application for an STC that can grant approval one day after the necessary documentation has been uploaded to the system, with the original documents to be subsequently submitted within five working days. Furthermore, the requirement for the translation and consularization of documents has also been removed.

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Technology is a key driver underpinning the development of securities markets across the world, facilitating everything from high-frequency trading, dematerialisation and straight-through processing. Asian exchanges have acknowledged the need to match their western counterparts by adopting the latest technology to serve the needs of global international investors. Much of these advancements however were restricted to the trading area.

In recent years, Asian exchanges have started to appreciate the value of post-trade reform1. This is due to a regional commitment to align with the Principles of Financial Markets Infrastructures, which has resulted in a series of technological initiatives aimed at market reform, setting standards via proprietary systems for trading and post-trade services.

Asian Exchanges have realised that their systems, which were once at the cutting edge, are now becoming dated and there is a growing need to replace these legacy platforms2. Conceptually, they are inclined towards breaking away from proprietary platforms and their end users by adopting market standard Application Program Interfaces (API) delivered through open-architecture messaging protocols – such as ISO 20022, the universal message scheme for the financial industry, and other XML-based application programme interfaces.

At the same time, Asian exchanges are investing more than ever before in their post-trade infrastructure, replacing their settlement and asset servicing platforms3. The European Union (EU) provides a model in Target2-Securities, a real-time settlement system that has set a precedent for open-architecture-based post-trade market infrastructure in Asia.

When it comes to open architecture, each market in the region is taking its own approach. Some have already made plans to upgrade their systems over the coming years, while others have not yet announced their future plans. But since open-architecture is likely to become a basic requirement among international investors, it is only a matter of time before it is a commonly adopted standard among exchanges4.

INFRASTRUCTURETOWARDS OPEN ARCHITECTURE

Notes:1. http://www.afme.eu/globalassets/downloads/afme-reports/afme-post-trade-explained.pdf, http://ec.europa.eu/finance/financial-markets/docs/clearing/eptf/160304-post-trade-services-ebf_en.pdf2. http://www.genpact.com/insight/case-study/asian-exchange-gets-new-trading-platform-to-bolster-growth-and-drive-innovation, https://www.hkex.com.hk/eng/newsconsul/newsltr/2012/Documents/2012-07-03-E.pdf3. Examples include: HKEx - https://www.hkex.com.hk/eng/newsconsul/newsltr/2012/Documents/2012-07-03-E.pdf ASX - http://asiaetrading.com/asx-to-invest-in-world-class-technology/ SGX and JPX - http://asiaetrading.com/jpx-and-sgx-launch-jpx-sgx-co-location-direct-service/4. https://www.opsview.com/resources/blog/how-stock-exchanges-made-linux-finance-it-standard

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AustraliaOpen-architecture is already the standard for local debt, and the ASX also recently introduced Corporate Event notifications from the CSD using ISO20022 messaging. By 2018, the Clearing House Electronic Subregister System (CHESS) is also expected to be upgraded where apart from the open architecture, even Distributed Ledger based technologies are being considered.

IndonesiaThe Indonesian CSD (Kustodian Sentral Efek Indonesia) plans to enhance the system, called C-BEST Next Generation project, by the second half of 2017 in order to support an increased system capacity and introduce a number of features, including but not limited to adopting international standard of settlement status, trade allegement, and to consider the adoption of ISO20022, most likely by 2018.

JapanIn 2014, Japan Securities Depository Center (JASDEC) introduced a next-generation system that moved some areas from mainframe computers to open system platforms and modifying the system structure. They have successfully also introduced ISO20022 messaging to connect their exchange participants with the depository.

SingaporeThe exchange has already implemented a new post-trade system that adopts the best practices and principles for clearing and settlement procedures. It complies with the market infrastructure standards set out by the International Organisation for Securities Commission (IOSCO), as well as ISO message standards.

VietnamThe VSD has no plans to use ISO20022 to communicate with depository members.

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One result of the global financial crisis is that it made regulators and G20 governments focus on reducing systemic risks associated with securities markets. To reach this end, there is a global drive towards reducing the settlement cycles. In Asia, many markets have announced that they are willing to shorten the settlement day to a T+2 model – a move prompted by announcements made by the US Securities and Exchange Commission (SEC) in the US and CSD reform in the EU.

A region-wide implementation of T+2 appears to put the region on track for a harmonised settlement cycle in Asia. But it is worth remembering that there are still inherent differences across markets and across a variety of factors – such as pre-matching requirements, settlement batches for cash and securities, as well as DVP rules and settlement finality norms.

While each market will introduce T+2 according to its own local situation, when considered from the perspective of a time gap between Asia and investors located in the US and Europe, the challenge becomes more acute. Markets in Asia will therefore be under pressure to meet an even tighter trade settlement schedule – a demand that will increase the need for further automation.

SETTLEMENTSHORTENING THE CYCLE

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AustraliaIn March 2016, Australia moved to a T+2 settlement cycle.

IndonesiaThe Indonesian Clearing and Guarantee Corporation (KPEI) together with the Indonesia Stock Exchange (IDX) and the Indonesia Central Securities Depository (KSEI) have announced their intention to move to a T+2 settlement cycle. The market is anticipating a number of challenges in the areas of funding and processing deadlines, considering the current market practices.

JapanThe settlement cycles for Japanese government bonds (JGB) are proposed to be reduced to T+1 from 2018 and that for equities to T+2 from 2019 based on updates received from the market. Settlement fails are anticipated to rise after the move to T+2 especially when one takes into consideration the local market practise of holding the Japanese Government Bonds (JGBs) as “clean” and “dirty” bonds for tax obligations on local investors. There is also a specific time limit that the bonds need to be held, so there are expectations there will be changes to the fail-trade regime.

SingaporeAlong with the post-trade change project the exchange is also looking at reducing its settlement cycle to T+2 coupled with the introduction of multiple settlement batches replacing the current single batch.

VietnamFrom January 2016, the VSD applied new settlement processes in which equities/fund certificates on-exchange transactions are settled on T+2 basis (instead of T+3) and ETF conversion transactions are settled on T+1 basis (instead of T+2).

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Most markets in Asia now have an established CSD and securities are generally settled on a scripless basis. The result is that routine functions – such as trade capture, pre-matching, settlements and reconciliation – have all become commoditised and highly scalable. But at the same time innovative forms of financial intermediation, along with a proliferation of new portfolio models, means that there is a growing number of international investors that want sophisticated services.

To meet these growing demands, CSDs in Asia are looking for creative solutions that enhance their value and presence in the securities marketplace. With most exchanges undergoing a process of demutualisation, regional CSDs have greater autonomy when it comes to defining and pursuing a strategic vision. All of these factors combine to prompt many CSDs in the region to expand their service offering to include new functions or asset classes into their proposition.

Global regulations also have a role to play in this trend. Rules such as UCITS, AIFMD, and the Dodd Frank Act have placed the responsibility of assessing the marketing infrastructure risk exposure firmly in the court of institutional investors, especially for regulated vehicles. Asian CSDs have responded by offering new services that include corporate event notification via SWIFT, electronic mediums for proxy voting and adding bonds and even investment funds to their universe.

AustraliaIn late 2015, the ASX introduced automated SWIFT-based messaging for corporate actions.

IndiaCSDs have started e-voting facility for meeting events and are also expected to provide a platform for routing mutual fund trade orders and its settlement in near future.

IndonesiaThe Indonesian CSD recently implemented their new fund order routing system called S-INVEST in August 2016 which helps investors to seamlessly invest in mutual funds and hold them in their depository accounts.

SingaporeThe Singapore Exchange (SGX) introduced corporate action messages via SWIFT to depository agents in 2015 and is currently also exploring a solution for proxy voting.

VietnamThe VSD is planning to introduce a new e-voting solution along with the ISO20022 rollout which will allow investors to cast their votes directly during shareholder meetings in electronic form.

CSDsMOVING UP THE VALUE CHAIN

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One consequence of the expanding regulatory framework for financial services is that is a large increase in the demand for data. Dodd-Frank, EMIR, and MIFID II are just some of the rules that require disseminating trade information to trade repositories and regulators on a near real-time basis. Many exchanges have entire departments running data services, which account for a significant share of overall revenues.

The need to record and store information is only going to grow in the coming years. MIFID II for example, introduces a best execution principle that requires investment firms to achieve the best possible result for their clients when executing orders for them, according to a range of factors. Data relating to raw orders and executions will become invaluable, as will be used to demonstrate the quality of trade execution.

This is the requirement of one major regulation. When the full range of international regulatory changes come into force, the amount of data that needs to be collected will be considerable. Financial firms should be thinking about the extraterritorial implications of these rules – especially in Asia, where exchanges are catching up increased data requests from clients and regulators.

Hong KongThere are growing requests for data relating to client assets to be retained for future retrieval.

IndonesiaRising demand for additional reports on a number of areas, such as substantial holdings reports to be reported to the regulator. Requests for reports on foreign exchange transactions, as well as tax reports for clients are also on the rise.

MalaysiaStandard requests include reports relating to securities trade transaction matching status, FX execution and substantial shareholding disclosure alert reporting.

DATAMEETING THE DEMAND FOR INFORMATION

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By highlighting the different issues that international investors face in Asia, the wide disparity in securities markets in the region becomes clear. It leads to a situation where many institutions are forced to maintain separate deployment projects for each market, with little opportunity for synergies between them. This kind of scattered approach is becoming increasingly difficult to justify amid the growing challenges that the financial industry faces – such as growing regulatory costs that reduce return on equity and the expenses associated with operational infrastructure.

Now could be the time to take a more strategic approach to post-trade systems and transition towards systems and processes that fit into a regional, or even global framework. We are already in a time of rapid change, with more to come in over the next five to ten years, which provides an opportunity for institutions to reassess their service models and decide which functions should be retained.

As Asia’s markets become more heavily regulated amid a drive for transparency in the global financial industry, the route towards the most optimal operating model will be a hard one to navigate. That is why it is essential to work with a bank that is in a strong position to prepare its partners for the markets of the future.

HSBC’s presence in Asian markets goes back more than a century, a long history that provides us with significant knowledge of securities trading and post-trading in the region. In addition, our truly global footprint allows us to deliver this expertise to partners wherever they are located. HSBC Securities Services’ comprehensive solution therefore enables financial institutions to implement a business strategy at the highest international standards, while in full compliance with local regulations.

As a major participant in markets across Asia, HSBC is viewed as a consultant by many exchanges and market intermediaries in the region, which puts us in a strong position to advocate international standards and harmonisation.

We are a strategic investor in SWIFTNet infrastructure in Asia, which allows us to extend ISO 20022 standards in more markets in the region when the platform is introduced. This is a good example of how we are able to help guide future market development to the benefit of market participants, as it means that our clients can limit the need to enhance their systems and interfaces to meet the unique requirements of every market.

Operating models will evolve in tandem with regulatory changes that affect international investors and structural developments that change Asian markets. Discovering the best model will be an ongoing process, and at HSBC, we are committed to partnering with our clients to create a solution that meets both local and international demands.

CONCLUSION

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For any enquiries please contact:

Clive TrianceGlobal Head of Sales and Business DevelopmentBanks and Broker DealersHSBC Securities Services

Email: clive.john.triance@hsbc.comPhone: +852 2996 6551

Issued November 2016This communication is issued by HSBC Bank plc. While all reasonable care has been taken in preparing this communication, no responsibility or liability is accepted for any errors of fact, omission or for any opinion expressed herein. You are advised to exercise your own independent judgment (with the advice of your professional advisers as necessary) with respect to the risks and consequences of any matter contained herein. HSBC expressly disclaims any liability and responsibility for any losses arising from any uses to which this communication is put and for any errors or omissions in this communication.The issuance of and details contained in this document, which is not for public circulation, does not constitute an offer or solicitation for, or advice that you should enter into, the purchase or sale of any security, commodity or other investment product or investment agreement, or any other contract, agreement or structure whatsoever. This document is intended for the use of clients who are professional clients or institutional customers, or eligible counterparties under the rules of the FCA, and is not intended for retail clients. This document is intended to be distributed in its entirety. Reproduction of this document, in whole or in part, or disclosure of any of its contents, without prior consent of HSBC or any associate, is prohibited. Unless governing law permits otherwise, you must contact a HSBC Group member in your home jurisdiction if you wish to use HSBC Group services in effecting a transaction in any investment mentioned in this document. HSBC Bank plcAuthorised by the Prudential Regulation Authority and regulated by the Financial ConductAuthority and the Prudential Regulation AuthorityRegistered in England No. 14259Registered Office: 8 Canada Square, London, E14

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