Regulatory reforms for securities market operations

Following is a letter to Ministry of Finance Secretary Dr. Harshana Suriyapperuma, Central Bank Governor Dr. Nandalal Weerasinghe, and SEC Chairman Prof. Hareendra Dissabandara, urging essential regulatory reforms to minimise securities market risks

Dear Sirs,

Essential regulatory reforms for securities market operations to minimise money laundering and other securities market risks

Media reports published over the last nine months have reported significant investments made by high net worth local and foreign investors in Government securities, the stock market and as Board of Investments approved private investments. 

These high-profile news making investments raise questions as to whether essential and optimum regulatory reviews and controls are in place, to ensure compliance with ‘know your customer’, and ‘source of funds’ legitimisations under the existing regulatory framework. Similar questions also arise as to whether effective regulatory processes are in place mitigating risks of round tripping, insider dealings, proxy investments via trusts where ultimate beneficial ownerships are not duly declared and other risks under securities market offenses.

A collective, prima facie risk review carried out by an accredited team of regulators together with law enforcement agency representatives has thus become a priority in eliminating any residual risks due to regulatory systems weaknesses to prevent potential significant money laundering and other securities market offenses which may be embedded within the current operational and regulatory compliance validations. 

The regulatory compliance validation framework must recognise that higher value transactions must be subjected to stronger, more comprehensive and wider in scope anti-money laundering compliance validation processes conducted by capable and competent officers. These validations must expand in scope as the value at risk enhances. For example, cumulative transactions over a defined period (say any 2-4 weeks) by a single person/business entity/group, exceeding successive step-up limits of transactions say above Rs. 500 million, Rs. 1 billion, and Rs. 5 billion should be subjected to compliance validations which expand in scope as the value at risk increases.

In pursuit of the above objective, it is evident that newly expanded and wider regulatory validation process requirements are issued binding effective enforcement of the following market participants:

1. All primary dealers

2. All stockbrokers

3. All banks and financial services institutions

4. All fund managers and unit trust managers

5. All investment companies 

These newly expanded regulations should in addition bind the following associated regulatory Institutions to set up appropriate compliance validation processes, which will reduce significantly the risks of money laundering and securities market offences:

1.Securities Exchange Commission

2. Public Debt Department

3. Colombo Stock Exchange

4. Board of Investments

The effectiveness of the compliance validation processes will be further strengthened if the regulatory institutions specified above, enter in to network support arrangements with the following State Institutions, preferably to be activated by information/intelligence/surveillance facilitation and sharing memorandums, with specific objectives and terms of reference for continuing network support:

1. Central Bank

2. Financial Intelligence Unit

3. Inland Revenue

4. Accounting and Auditing Standards Monitoring Board

It is hoped that the accredited team of regulators and law enforcement agency representatives undertaking the prima facie review will form in to a committee and develop the expanded in scope new regulations to enhance the effectiveness of the regulatory compliance validations by the listed market participants. These regulations can be published and market participants must be made aware of the essential need for same within a control regime committed to minimise corruption and enhance transparency of market operations.

A review suggestion note is attached, setting out a potential draft framework for the new expanded compliance validations processes to be enforced by banks and financial institutions, who are considered the primary accountability pillar supporting the regulatory institutions in enforcing effective regulatory control validations post investments with the objective of strengthening the systems currently in place.

Yours Sincerely,

Chandra Jayaratne

cc. President and Minister of Finance, Planning and Economic Development

Minister of Justice and National Integration

 Attorney General

Secretary, Ministry of Public Security

Director FIU,

Director Public Debt Management Department

Chairman, Colombo Stock Exchange

Chairman, Board of Investments

IMF Diagnostics Team

Editor, Daily FT for media publication

Review suggestion

1. For all new securities market investment transactions made during a specified period (say any 30-day period) by an individual, company or group or financial services entity, exceeding Rs. 500 million but not exceeding Rs. 1 billion, the associated Bank or Financial Services Entity deployed in making such investment, to have in place a register/ICT records and file with the relevant regulator a half yearly updated “Know Your Customer” declaration forms covering such investments, supported with specific information on associated related parties and details of any standing credit/overdraft/accommodation/loans to the investor 

2. For all new securities market investment transactions during a specified period (say any 30-day period) by an individual, company, group, or financial services entity, exceeding Rs. 1 billion, but not exceeding Rs. 5 billion, the associated Bank or Financial Services Entity deployed in making such investment, to have in place register/ICT records and file with the relevant regulator a half yearly updated “Know Your Customer” declaration form along with a detailed source of funds and purpose of the investment declarations made by the investor and details of any standing credit/overdraft/accommodation/loans to the investor 

3. For all new securities market investment transactions during a specified period (say any 30-day period) by an individual, company or group or financial services entity the associated Bank or Financial Services Entity deployed in making such investment exceeding Rs. 5 billion to have in place a register/ICT records and file with the relevant regulator a half yearly updated “Know Your Customer” declaration form as specified in 1 above, along with a detailed source of funds, purpose of the investment declaration together with the most recent Financial Statement of net wealth or Tax Return and a Cash Flow position of the individual/entity and details of any standing credit/overdraft/accommodation/loans to the investor

4. The relevant regulatory institutions must be empowered upon valid justifications to exempt by an order of its top management/board any entity from the above detailed validation processes being any individual, company or group or financial services entity with an acceptable track record in investments and financial services supported by effective anti-money laundering and associated securities trading risk mitigation controls.

5. The relevant regulators must in place compliance validation processes of half yearly returns and associated documents as received; and where appropriate the raising of Suspicious Transaction Reports, to be duly shared with relevant network agencies including any specific law enforcement agency covering financial crimes investigation

6. Where the Source of Funds Statements submitted to the relevant regulatory institution notes that the source of funds have been raised in any unusual manner and/or from sources external to the investor or by suspicious round tripping or such funds have been raised leveraging external temporary advances, accommodations or loans granted by unknown funders/banks and financial institutions, related parties, other persons or institutions or parties classified as high risk entities/sectors by the Financial Action Task Force and or involve politically exposed persons, such information must be subjected to heightened validations and investigations and following such reviews and where warranted raising Suspicious Transaction Reports

7. Where the party investing/trading or funding high value transactions which fall within limits set in 1, 2 and 3 above, and relate to an individual, company or group or financial services entity, and are –

a. Persons or entities previously subjected to close review for 

- FATF/FIU high risk tagged persons

- persons/institutions who are listed as high risk persons due to past experiences based watch parties or are surveillance amber signalled persons

- Politically exposed persons

- acknowledged related parties of any of the above persons

- any institutions believed to be round tripping or using trusts and intermediaries to hide the real beneficial owners

- heightened validations and investigations may be warranted in ascertaining the facts for reporting via Suspicious Transaction Reports if found to be a high-risk transaction

8. All parties referred to below found having ineffective ‘Know Your Customer’ processes, or failing to discharge initial valid assessments of the transactions at an acceptable level or failing to alert regulators of likely noncompliance with laws and regulations or concealing any potential high-risk transactions wilfully and knowingly be associated with any type of securities market investments must compulsorily be made subject to penal provisions

o All primary dealers

o All stockbrokers

o All banks and financial services institutions

o All fund managers and unit trust managers

o Any investment company

o All persons/entities and groups engaging in securities market transactions in the defined period exceeding the limits set

9. All regulatory agencies with oversight accountability over securities market transactions must be required to enter into network support arrangements with relevant State institutions, preferably covered by formal information/intelligence/surveillance facilitation and sharing memorandums, with the specific objectives and terms of reference for network support in assuring effective anti-money laundering and securities market offenses based controls;

10. State institutions covered by network agreements referred to in 9 above to assist the Securities Market Regulators by providing network intelligence/information sharing and follow up investigation facilitations and in enforcement of penal sanctions for noncompliance, sharing suspicious transaction reports, instances of warnings, compounding and deferred prosecution, etc.

11. All persons, business entities banks, financial services businesses and related company directors and secretaries of investing companies must also be required to validate due compliance with all regulations issued by the Financial Intelligence Unit and be further required to actively engage in reporting any noncompliance with laws and regulations governing the securities market operations