Introduction

In our previous issue of the Regulatory & Compliance newsletter in April 2019 (“Previous Issue”), we discussed the disciplinary actions (the “Disciplinary Actions”) taken by the Securities and Futures Commission (“SFC”) on 14 March 2019 against UBS AG and UBS Securities Hong Kong Limited (“UBS Securities Hong Kong”) (collectively, “UBS”) and some other sponsor firms in relation to their failures in discharging their duties as sponsors for certain listing applications on the Stock Exchange of Hong Kong Limited (“SEHK”). The sanctions imposed on UBS included, among others, the suspension of the licences of UBS Securities Hong Kong to advise on corporate finance for one year.

On 14 January 2020, the SFC lifted the suspension of UBS Securities Hong Kong to act as a sponsor for listing applications on the SEHK, after satisfying itself that UBS had implemented adequate and effective systems and controls in relation to the conduct of its sponsorship business.

Background

By way of recap to our Previous Issue, the Disciplinary Actions mainly concerned the listing applications of China Forestry Holdings Company Limited (“China Forestry”) in 2009 and Tianhe Chemicals Group Limited (“Tianhe”) in 2014. UBS was one of the joint sponsors in the respective listing application of China Forestry and Tianhe. For details relating to the failures to conduct proper due diligence work by UBS and its joint sponsors, please revisit our Previous Issue.

Independent review

In its Statement of Disciplinary Action, the SFC stated that in deciding the sanctions it had taken into the fact that UBS had agreed to engage an independent reviewer (the “Reviewer”) to review its policies, procedures and practices in relation to the conduct of its sponsorship business. UBS then engaged and cooperated with the Reviewer accordingly. It was discovered that UBS has been enhancing its systems and controls in relation to the conduct of its sponsorship business since 2009. The areas of enhancement included the areas which the SFC was primarily concerned about and which led to the Disciplinary Actions, i.e. UBS’s practice surrounding the conduct of customers and suppliers due diligence interviews, inspection of material assets, and maintenance of records to demonstrate verification of the identities of the interviewees, places of interviews and the existence and general condition of the material assets inspected.

During the Reviewer’s 10-month review on UBS’ s enhanced governance processes from the acceptance of a sponsorship mandate to the listing of a listing applicant, the Reviewer found that UBS’s governance and control processes applicable to the conduct of its sponsorship business are generally well-designed. The assessment of the Reviewer took into account a number of key controls of UBS, including:

1.        a framework of processes, reviews, governance and oversight within UBS’s first line of defense. Whilst a sponsor’s first line of defense would usually be those who identify obvious discrepancies and mismatch between factual matters and matters disclosed in prospectus, sponsor firms should ensure that such matters are effectively communicated with and clearly reported to sponsor principals;

2.        policies setting out specific responsibilities for dedicated first line of defense control functions of the sponsorship business. Ideally, such policies would include plans and checklists as to how due diligence should be conducted and what is expected from the team members;

3.        adequate and appropriate forums for escalation of material issues identified across the entire deal cycle for discussion with management senior to the sponsor principal (including managers-in-charge) on a specific mandate. To ensure that irregularities are squarely explained and resolved, sponsor firms are encouraged to hold regular committees to review and manage red flags that are raised;

4.        adequate involvement of the independent second line of defence, i.e., the compliance and operational risk functions. The purpose of having a separate entity to perform this function is to critically examine and challenge the work conducted by its deal teams; and

5.        an audit programme designed and executed by internal audit as the third line of defense, which is adequate to sufficiently discharge their responsibility and perform annual assessments to ensure that both UBS and its systems and controls remain effective and compliant with the relevant regulatory requirements.

The above key controls were shown to have implemented in UBS’s sponsor work in its two most recent listing applications completed in 2017 and 2018, which were examined by the Reviewer. Accordingly, UBS performed adequate and effective due diligence in discharging its responsibilities as a sponsor.

The SFC’s stance

The Reviewer’s findings are not conclusive. Despite the co-operation between the Reviewer and UBS, the SFC would assess the Reviewer’s findings of UBS by obtaining supporting documents for its findings from the Reviewer, and seeking explanations from the Reviewer for its conclusions about the adequacy and effectiveness of UBS’s governance framework and control processes. The SFC would need to satisfy itself that UBS has clear requirements and procedures in place to enable its staff members to understand and properly perform their responsibilities, and that there are adequate and effective systems, controls, policies and procedures to enable compliance with the legal and regulatory requirements for its sponsorship business.

Conclusion

The case of UBS demonstrates that it remains possible to negotiate with the SFC to mitigate the sanctions even after they are imposed. Although the SFC had decided that the licences of UBS Securities Hong Kong to advise on corporate finance were to be suspended for one year, eventually the suspension was uplifted after 10 months as UBS successfully demonstrated to the SFC that it had achieved regulatory compliance by attaining the high standard expected by the regulator. In any event, sponsor firms should bear in mind the high standards expected of them as licensed sponsors and the importance of close management attention and supervision to effective regulatory compliance.