Compliance risks have become increasingly onerous for firms in China. In particular, compliance requirements for the financial sector have become stricter in recent years, as regulatory authorities seek to ensure stability in the financial system. 

This development has created new challenges for in-house counsels and there is now a need for them to adopt new strategies to manage this risk. 

“I do have an impression that in recent years China has been putting in a lot of effort to catch up with its international peers in terms of compliance standards,” says Edward Yeung, who is working in the anti-money-laundering (AML) department in the Bank of Singapore. Yeung is also a former AML compliance officer at Industrial and Commercial Bank of China (ICBC). 

President Xi Jinping is said to be determined to clean up the country’s financial industry after the $5 trillion stock meltdown in 2015, which exposed the nation’s financial risks. The country’s central bank has injected 160 trillion yuan ($23.8 trillion) into the market to aid recovery of the economy following the stock market collapse, but the majority of the funds were reportedly just being transferred between financial products and creating bubbles, instead of going into profitable projects that would stimulate economic growth. 

In response, China has released a number of guidelines and rules in the past year to tighten regulation of financial institutions, including banks, brokerages and insurers. The Chinese authorities have taken numerous actions to ensure tougher fundamental risk control and mitigate risk within the sector. 

Guo Shuqing, newly appointed chairman of China Banking Regulatory Commission, has fined a number of institutions that failed to meet compliance requirements. In April, 17 banks were flagged and penalized some tens of millions of yuan on violations of “evading supervision” and “illegal operation”. 

This has created a huge headache for China-based firms and their in-house counsels. 

In recent years, Chinese banks have seen a slower growth in their loan business and continued pressure on their net interest margin. As a result, the banks have been expanding their range of financial products and invested a huge amount of capital into bond markets in order to remain competitive. 

A tighter compliance requirement could potentially mean the offering of such products may be limited or even banned in the future. While a better compliance system within the country is beneficial for its financial health in the long term, this has certainly imposed a greater challenge for in-house lawyers to ensure that their companies comply with new laws while minimizing the impact on profitability. 

Following such development, Chinese banks have reportedly been strengthening their risk management and compliance programs. A survey by LexisNexis Risk Solutions, a compliance service provider, showed that about half of state-owned commercial banks expect to increase their compliance budgets by 20 percent or more this year. 

BANKS RESPONDING

The banks are now responding with more training and an overhaul of their compliance systems. 

In particular, Bank of China said it has now employed big data analytics to review the risk features of violations and convert the data into a control model implanted into the system, which will analyze bank accounts, transactions and spot suspicious activities. This is in addition to a three-year plan the bank has announced to provide special AML training for management and staff, with the aim of producing 200 certified AML specialists. 

ICBC also said last year that it had improved its AML systems and supervision of overseas institutions, measures that it said to have “effectively prevented the anti-money laundering compliance risk and reputational risk.” 

Another big four bank, China Construction Bank Corp, has reportedly agreed to revamp its transaction controls, oversight and reporting controls in a deal with the US Federal Reserve.

Numerous incidents in the past years have supported the argument that some Chinese financial institutions have room for improvement when it comes to compliance duties. In November 2016, Agricultural Bank of China was fined $215 million by US regulators for violating AML rules by deliberately obscuring potentially suspicious transactions and silencing its compliance officer. 

And this is not an isolated case. 

China Construction Bank was warned for similar issues, and a couple of ICBC and Bank of China bankers were arrested in Europe last year for suspected AML fraud. 

These legal and regulatory headaches are a drag on the banks’ overseas expansion plans, as they are likely prevented from opening new branches or lines of business for at least three years following those high-profile investigations.

“Chinese banks do have a more casual mindset when it comes to compliance issues,” said Yeung.

“I also feel like some Chinese firms still fall short in their AML and know-your-client duties compared to their peers in Singapore and Hong Kong, which are subject to their own local monetary authority rules,” said Yeung.

Insurers – another big player in the financial industry – also face tighter rules, as regulators have stepped up scrutiny with four new measures last month. 

China Insurance Regulatory Commission (CIRC) has said they were concerned with the bidding up of stocks using leverage, and to avoid conflicts of interests, insurers were ordered to ensure no overlapping of roles between the head compliance officer and the senior management of other departments. 

Earlier this year, industry giant Evergrande Group was penalized by CIRC for unlawful use of insurance funds in some of their stock trading activities last year. The company was suspended from stock trading for a year as a result. 

The punishment against Evergrande followed the ban on Foresea Life’s chairman from the insurance sector for 10 years. And Baoneng Group, another industry heavy weight, was clamped down on universal life products offered by their insurance units. 

CIRC said that short-term speculation conducted by the company from late September to early November last year caused severe social consequences. Two executives of Baoneng were accused of the unlawful activities and are banned from the insurance sector for five and three years. These penalties show the determination of the regulators to curb risky investments by insurers.

In response, many insurers and insurance asset management companies have now established a new compliance management framework that includes a whistle blower system, according to CIRC. The goal of the new compliance framework is to allow the companies’ operations department, compliance department and internal audit department to work together to ensure proper governance.

Managing compliance risk has become an increasingly challenging and important task for in-house lawyers. An inadequate compliance program could have a major impact on the company’s profitability and reputation.