24 December, 2018
On 19 December 2018, the Hong Kong Monetary Authority (HKMA) announced that it will introduce supervisory measures (Supervisory Measures) focused specifically on measuring authorised institutions’ (AI) progress in implementing reforms to their culture. The Supervisory Measures include requiring AIs to complete and return self-assessment forms regarding their culture to the HKMA, and undertaking on-site reviews focused specifically on culture.
These new measures follow the HKMA’s March 2017 Bank Culture Reform Circular (BCR Circular), which set out a framework for fostering sound bank culture and required AIs to review and enhance their existing governance arrangements by March 2018 (see our bulletin here on the BCR Circular and the HKMA’s broader program of corporate governance enhancements). The announcement of the Supervisory Measures clearly indicates that the HKMA remains focused on the culture of Hong Kong banks, and will be closely scrutinising the work undertaken to comply with the BCR Circular, as well as more general culture and conduct reforms. Importantly, the HKMA has also suggested that further guidance may be forthcoming if it considers that AIs have not done enough to enhance their culture.
The Supervisory Measures
The HKMA has announced that it will introduce three Supervisory Measures:
1. Self-assessment: Most significantly, the HKMA has indicated that it will require AIs to undertake a self-assessment of their culture. The HKMA has designed a template to assist the AIs in conducting the self-assessment. This template, which is enclosed as an annex to the HKMA's guidance, is divided into two parts.
Part A requires the AI's board to answer a series of detailed questions regarding their role in sound bank culture, including, for example, identifying:
- proactive steps undertaken by the board in driving culture reforms;
- the most salient indicators used by the board to measure and assess their culture;
- how overseas-incorporated AIs' cultural measures interface with those enacted by their head office; and
- the tangible outcomes the board has observed from fostering a sound culture.
Part B of the self-assessment is focused on requiring AIs to identify either:
- how they have already implemented each aspect of the HKMA's guidance in the BCR Circular, including by providing granular examples and evidence of the implementation of these measures; or
- explaining why they have not done so, including by providing action plans with target implementation dates, or outlining alternative actions undertaken for the purpose of complying with the BCR.
The HKMA has also directed that Part B of the self-assessment should be completed by an AI's internal audit or compliance function.
2. Conducting focus reviews: The HKMA has indicated that it will undertake both site visits and off-site reviews to review and benchmark AIs' practices with respect to key areas of bank culture. We anticipate that these key areas will include at a minimum the following three pillars of bank culture identified in the BCR Circular:
- governance (including the role of the board and senior management in overseeing culture and conduct);
- incentive systems; and
- assessment and feedback mechanisms.
3. Undertaking culture dialogues: The HKMA will also meet with senior management and / or board members of AIs responsible for bank culture in order to gather insights on their approach to culture.
Notably, engaging in high level discussions and undertaking specific supervisory reviews focused on culture were identified by the Financial Stability Board (FSB) in April 2018 as measures for use by regulators in reducing misconduct risk (see our bulletin here on the FSB’s new global toolkit for fighting misconduct risk and what it means for firms and regulators).
Implications for AIs
The HKMA has indicated that it will undertake the self-assessment by phases, with the first phase covering 30 AIs, including all major retail banks and certain foreign bank branches with substantial operations in Hong Kong. Those AIs notified by the HKMA as being included in the first phase will be expected to submit their completed self-assessment forms to the HKMA within six months. However, those AIs not selected for the first phase will still be expected to reflect on their own cultural enhancement initiatives, including lessons learned.
It is clear from the HKMA’s template self-assessment form that it expects AIs to provide a significant amount of data regarding their culture reform initiatives. Given the level of granularity expected, and the level of senior management involvement which is likely to be required, we anticipate that completing the forms is likely to be a resource-intensive and time-consuming process for AIs. Those AIs selected to take part in the first phase should start work on completing their self-assessment form as soon as possible.
We also recommend that those AIs not selected to take part in the first phase prepare themselves for participation in a future phase, including by undertaking an internal self-assessment as a “dry run” in addition to more general reflection on their work in this area to date.
Finally, the HKMA has stated that the pursuit of sound banking culture is a common aspiration of global regulators, and as part of this, it expects AIs in Hong Kong to learn from misconduct occurring overseas. In particular, the HKMA has flagged that it expects that AIs’ self-assessment will include active consideration of findings from major misconduct incidents arising outside of Hong Kong for the purposes of:
- assessing whether the AI might be at risk of similar misconduct issues; and
- benchmarking their culture and behavioural standards against community standards and expectations.
The HKMA also noted that it expects that these findings will be reported to boards as appropriate, and identified a recent example of such findings as those of the Australian Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.
For further information, please contact:
William Hallat, Herbert Smith Freehills
william.hallatt@hsf.com
