Emerging and Current regulatory Issues in the Capital · PDF filepressure to maintain share...

SECURITIES INDUSTRY DEVELOPMENT CORPORATION © Copyright SIDC

Emerging and Current Regulatory Issues in the Capital Market (Session 1)

Module 4

V2


2

Notice

• The views expressed here are solely those of the speaker in his private capacity and do not in any way represent the views of the Securities Industry Development Corporation (SIDC) or the Securities Commission Malaysia (SC).

• The cases mentioned in this presentation have been prepared, cited or described on the basis for discussion rather than to illustrate either effective or ineffective handling of a business situation.

• No part of this presentation may be reproduced, stored in a retrieval system

or transmitted in any form or by any means without the permission of the SIDC.


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Risk Management

Systemic Risk

Stress Test


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Risk Management

• Systemic risk

The possibility that an event at the company level could trigger severe instability or collapse an entire industry or economy.

• Stress test (internally or by regulators)

An analysis conducted under unfavorable economic scenarios which is designed to determine whether a financial institution has enough capital to withstand the impact of adverse developments.


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Changes to Financial Landscape

• Banking

• Insurance

• Capital market

Blurring of Lines and Increased Linkages

• New products

• New services Greater Financial

Innovation


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Prudential Standards - BNM

• Prescriptive rules and requirements include:

– minimum Capital Adequacy Requirements;

– prudential limits on excessive risk-taking;

– specific guidance on minimum standards of sound management; and

– regulatory requirements to address present and emerging risks (e.g. imposed under conditions of distress).


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Prudential Standards - BNM

• The prudential framework is regularly reviewed and updated to adapt to changing market realities and takes into account developments in international standards and guidance issued by the Basel Committee on Banking Supervision, the International Association of Insurance Supervisors and the Islamic Financial Services Board.


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Prudential Standards – Capital Adequacy Requirements

• Capital Adequacy Requirements (CAR) enables POs to identify the capital available to cover the risk of their business.

• The focus of CAR is to ensure that a PO’s financial resources and capital be maintained in a ready liquid form to meet the sum of individual risk areas of the PO.


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Capital Adequacy Requirements – Total Risk Requirements

Operational risk

Counterparty risk

Large-exposure risk

Underwriting risk

Position risk


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• CAR is measured by ratio linking the liquid capital of the PO to its total measured risks.

• The ratio will alert BMSB of any potential liquidity problems of the PO, and therefore trigger closer monitoring of the PO at an early stage.

• The ratio will also enable POs to manage their risk proactively.


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• CAR is measured through the level of liquid capital and total risk requirement.

• Rules of BMSB, the PO must ensure that:

– it’s liquid capital is at all times greater than its total risk requirements

– it’s core capital is at all times greater than its operational risk requirements


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Reputation risk

Reputation Risk

Peripheral Parties

Employee Action

Company Action


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Remuneration driving malpractices;

• Unreasonable KPIs may encourage creative accounting or fraudulent accounting.

• CEO and senior management rewards often tied to achieving profit KPI (especially unreasonable stretch KPIs).

• If CEO executive director’s shares have been pledged, there is great pressure to maintain share price lest there be margin calls.


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Not adhering to KYC protocols;

• Know your customer (KYC) and Continuous Due Diligence (CDD) are processes used by a business to verify the identity and intention of their clients.

• Why?

– to prevent financial fraud;

– to prevent money laundering, terrorist financing, proceeds from unlawful activities; and

– to give appropriate advice to investing clients .


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Key Elements of AMLA Framework

1. Internal Controls, Policies and Accountabilities

2. Know Your Client

3. Education and Training

4. Monitoring and Detection

5. Reporting Obligations and Procedures

6. Record Keeping

7. Compliance Programme


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Conflicts of Interest

Primary Interest

Secondary Interest


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• Duties of Directors

• Integrity of Research

• Protection of Clients

Primary

Interest

• Financial Gain

• Professional Advancement

• Do Favours (family, friends)

Secondary

Interest


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• Conflict of interest exists if the circumstances are reasonably believed (on the basis of past experience and objective evidence) to create a risk that decisions may be unduly influenced by secondary interests.


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• PO Trading in Competition with Client

Conflict: PO buys or sells before the client and gets a better price for itself than for the client.

Duty: The PO must give the client’s order priority.

• PO Trading as Principal with the Client

Conflict: the PO’s interest to achieve the best price for itself can conflict with the duty to obtain the best price for the client. The client may be able to buy or sell at a better price elsewhere.

Duty: The PO must make full disclosure of the fact that it is acting as a principal.


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• PO is Underwriter of Shares and Also Acts for Clients Who Buy Shares

Conflict: The PO faces losses if the underwritten issue is not fully subscribed. Its interest in encouraging clients to buy the shares conflicts with its duty to act in the best interest of its clients.

Duty: The PO must disclose that it has acted as an underwriter so that clients are aware that its advice may be biased.


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• PO Owns Shares and Recommends These Shares to Clients, But Does Not Trade Directly with Them

Conflict: It is in the PO’s interest to see a price increase for shares that it owns. The price of the PO’s shares is likely to rise if its clients buy those shares.

Duty: The PO must disclose the nature of its shareholding to its clients so that they are aware that its advice might be biased.


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• A conflict of interest is a manifestation of moral hazard, particularly when a financial institution provides multiple services and the potentially competing interests of those services may lead to a concealment of information or dissemination of misleading information.

• A conflict of interest exists when a party to a transaction could potentially make a gain from taking actions that are detrimental to the other party in the transaction.


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• There are many types of conflicts of interest such as a "pump and dump" by stockbrokers.

• This is when a stockbroker who owns a security artificially inflates the price by upgrading it or spreading rumors, and then sells the security.

• They will then downgrade the security or spread negative rumors to push the price back down. It is a conflict of interest because the stockbrokers are concealing and manipulating information to make it misleading for the buyers.


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• The broker may claim to have the "inside" information about impeding news and will urge buyers to buy the stock quickly. Investors will buy the stock, which creates a high demand and raises the prices.

• This rise in prices can entice more people to believe the hype and then buy shares as well.

• The stockbrokers will then sell their shares and stop promoting, the price will drop, and other investors are left holding stock that is worth nothing compared to what they paid for it.

• The brokers are using their knowledge and position in a way to influence and control others and gain personally.


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• Codes of ethics help to minimize problems with conflicts of interests because they can spell out the extent to which such conflicts should be avoided, and what the parties should do where such conflicts are permitted by a code of ethics (disclosure, recusal, etc.).

• Thus, professionals cannot claim that they were unaware that their improper behavior was unethical.

• Disciplinary action (for example, a dealers representative being struck-off the Register) helps to minimize unacceptable conflicts or improper acts.


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Approaches to Managing Conflict of Interest

• code of ethics,

• disciplinary actions on wrong-doings,

• policy of receiving gifts,

• personal dealing by staff,

• ‘Chinese Walls’, and

• procedures for dealing with situation where someone declares being conflicted.


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Churning customers accounts

• Excessive trading by a broker in a client's account largely to generate commissions or to create the impression of bona fide high trading volume and/or value.

• While there is no quantitative measure for churning, frequent buying and selling of securities with no-change-in-beneficial-ownership (NCBO) or by ‘acting-in-concert ‘may be construed as evidence of churning.


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Approaches to mitigate churning

• Monitor volume of trades being executed (on real time basis)

• Monitor CDS accounts for trades with no-change-in-beneficial-ownership (NCBO), or

• For trades that use the same CDS accounts (acting-in-concert)

• Monitor stocks that have been highlighted as of concern by BMSB

• Impose limits on dealers representatives and/or clients (ask for percentage cash up-front stocks up-front)


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Securities Industries Dispute Resolution Centre (SIDREC)

• SIDREC is an independent body corporate established for the settlement of disputes between investors and capital market intermediaries who are its members such stockbrokers, futures brokers, unit trust management companies and fund managers.

• SIDREC provides investors with free, fast, convenient and efficient avenue to refer disputes for resolution as an alternative to the other current dispute resolution body.

• As an approved body corporate under the Capital Markets and Services Act (Dispute Resolution) Regulation 2010, SIDREC provides an affordable and accessible one-stop avenue for investors to resolve their disputes with capital market intermediaries.


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SIDREC Claims Statistics

Year

Adjudicated Adjudicated

Adjudicated

Successfully mediated

Claims resolved

(no med or adj)

Claims resolved

(no med or adj)

Total claims resolved

Full award against

member

Partial award against

member

Dismissed claim

Claim withdrawn by claimant

Dismissed at stage of

initial assessment

2014 0 1 2 1 13 2 19

2013 2 2 2 0 13 1 20

2012 0 0 0 0 2 1 3

2011 0 3 0 0 0 0 3

Total 2 6 4 1 28 4 45


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Differentiating between Guidance and Advice

• What is investment Guidance?

– Where consumers are provided with information which is designed to help them make their own investment decisions.

• Such guidance can include the following:

– Financial and investment education

– General information about different types of product and asset classes can be given along with an explanation of how the consumer’s attitude to investment risk can be determined.

– Specific investment concepts such as diversification and optimisation can also be covered.


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Differentiating between Guidance and Advice

• What is investment Advice?

– a personal recommendation as to how consumers should invest their money, taking into account their own particular circumstances and their financial objectives.

– BMSB requires certain steps to be carried out by dealers representatives and advisers, before any advice is given, including conducting a suitability assessment (KYC).

– This process should take into account all aspects of a client’s investment objectives and financial circumstances, including the risk they are willing and able to take on, ensuring any investment recommendations are appropriately aligned to their specific situation.


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Cyber-threats - Containerization

• An interesting new concept is “containerization.”

• Implementing new software in trading technology is a complicated process especially to move new software from the test environment to production and ensure full compatibility with all of the existing production components.

• What containerization does is it provides you with the entire technology environment for that software – everything is self-contained within the container.

• This structure mitigates compatibility issues and reduces the risk of introducing new software into production.


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Cyber threats – Hardware Acceleration

• Another trend that will have a major impact on capital markets is hardware acceleration, which allows processing in parallel rather than the traditional sequential model.

• This is done by looking at the latency sensitive components of the architecture and seeing where hardware acceleration can be applied.


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Data leak prevention

• Over the last decade, enterprises have become increasingly reliant on digital information to meet business objectives.

• On any given business day, significant amounts of information fuel business processes that involve parties both inside and outside of enterprise network boundaries.

• There are many paths for these data to travel and they can travel in many forms—e-mail messages, word processing documents, spreadsheets, database flat files and instant messaging are a few examples.


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Data leak prevention

• Much of this information is innocuous, but in many cases a significant subset is categorized as “sensitive” or “proprietary,” indicating that this information needs to be protected from unauthorized access or exposure.

• This need can be externally driven by privacy and other types of regulation, or internally driven by business objectives to protect financial, strategic or other types of competitive information.


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Fraud & Identity Theft

• Identifying types of fraud

• Social Engineering

• Email Scams and Spoofs

• Lottery Scams

• Nigerian Scams

• Mystery Shopper

• Check Scams

• Key-Logging

• Man in the Middle Attacks

• Malware

• Protect Your Personal Information

• Suspicious Activity on Your Credit Report

• Identity Theft


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Distributed Denial-of-Service attack (DDoS)

• A Distributed Denial-of-Service (DDoS) attack is one in which a multitude of compromised systems attack a single target, thereby causing denial of service for users of the targeted system.

• The flood of incoming messages to the target system essentially forces it to shut down, thereby denying service to the system to legitimate users.


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Distributed Denial-of-Service attack (DDoS)

• In a typical DDoS attack, the assailant begins by exploiting a vulnerability in one computer system and making it the DDoS master. The attack master, identifies and infects other vulnerable systems with malware.

• Eventually, the assailant instructs the controlled machines to launch an attack against a specified target.


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Emerging and Current regulatory Issues in the Capital · PDF filepressure to maintain share...

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