Tuesday, May 17, 2011

SFC Regulation of Credit Rating Agencies in Hong Kong Begins on June 1

Beginning June 1, 2011 the Hong Kong Securities and Futures Commission will license and regulate credit rating agencies pursuant to amendments to the Securities and Futures Ordinance. The creation of a regulatory regime for rating agencies follows a public consultation exercise that was conducted by the SFC in 2010. The Commission has also adopted a Code of Conduct for persons providing credit ratings.

Among other things, the Code provides that a rating agency should implement and enforce procedures to document reporting lines and allocate functions and responsibilities and ensure that the credit ratings it prepares are based on a thorough analysis of all relevant information known to the agency. In addition, rating methodologies should be rigorous, systematic, and, where possible, result in ratings that can be subjected to objective validation based on historical experience, including back-testing.

The regulation of credit rating agencies will bring Hong Kong’s regulatory regime in line with international developments in this area, said Martin Wheatley, the SFC’s Chief Executive Officer, who added that the Commission encourages credit rating agencies to seek further clarification, if needed, of the licensing requirements and the manner ion which they are being implemented.

Hong Kong is the base from which major multinational credit rating agencies conduct business in the Asia Pacific region. Some smaller rating agencies also have offices in Hong Kong. The legislation designates providing credit rating services as a new type of regulated activity under which credit rating agencies and their individual analysts will be subject to licensing requirements and ongoing regulation by the Commission.

A firm that prepares credit ratings only for its internal use, such as a bank’s internal systems for assessing counterparty risks, will not be regarded as providing credit rating services for the purposes of the legislation, explained the Commission, because the credit ratings would neither be intended for dissemination to the public nor reasonably expected to be so disseminated. Consumer credit reference agencies are also excluded from the regulatory regime because the definition of credit ratings under the legislation excludes opinions regarding the creditworthiness of individuals.

Further, only a staff member who prepares credit ratings for a ratings agency would have to be licensed. Marketing or business development activities would not be regarded as providing credit rating services under the legislation. Thus, individuals who solely perform these activities would not have to be licensed.

Staff members who only collect and prepare credit data for the rating analysts without performing any analysis would not be regarded as performing a regulated function in relation to providing credit rating services. Similarly, an overseas-based rating analyst participating in a rating committee meeting via telephone conference or video conference with a Hong King- licensed credit rating agency would not have to be licensed.

In general, a credit rating agency should not carry on any business which can reasonably be considered to have the potential to give rise to any conflict of interest in relation to its business of providing credit rating services. Rating agencies are not allowed to provide consultancy or advisory services to a related entity, or its related party, regarding the corporate or legal structure, assets, liabilities or activities of that rated entity or related party.

A credit rating agency with a small operation in Hong Kong may outsource back office functions to its group companies or external professional or consulting firms. However, the rating agency and its senior management would remain fully and ultimately responsible for the performance of the compliance function and the outsourced activities.

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