Hong Kong, China Framework Comparison – KYC Standards (Part 2)
As China opens up the banking sector to foreign players at an unprecedented rate, many international banks — especially those that already have a strong presence in Hong Kong, and have shown a keen interest in exploring the Mainland China market. In this series of three articles, we will examine the regulatory differences between Hong Kong and Mainland China, as well as the challenges of complying in a dynamic regulatory environment. Second comparison – Focus on KYC Standards in Hong Kong and Mainland China
War against money laundering activities dates back to the 1930s, when the United States issued laws to fight against organized crime. Then, the 9/11 attack in 2001 led to increased emphasis on Anti-Money Laundering (AML) and Counter-Financing of Terrorism (CFT). A key component of AML, Know Your Customer (KYC) procedures remain a crucial stage for all banks, since it is where the risk of money laundering is not only detected, but also mitigated to an acceptable level. Therefore, ensuring accurate and efficient KYC policies from regulatory bodies, coupled with rigorous KYC frameworks can largely mitigate money laundering risks at banks.
Hong Kong, being one of the largest financial centers in Asia, and Mainland China, being a global economic superpower, remain a breeding ground for money laundering activity. Strengthening enforcement and monitoring KYC policies for customer identification is the need of the hour. The respective regulatory bodies – the Hong Kong Monetary Authority (HKMA) and the Securities and Futures Commission (SFC) for Hong Kong, and the People’s Bank of China (PBOC), the China Banking and Insurance Regulatory Commission (CBIRC) and the China Securities Regulatory Commission (CSRC) for Mainland China — are aware of this threat. They have been continuously making efforts to tighten KYC compliance requirements.
In 2017, HKMA conducted 1,820 ML investigations1, showcasing the strict attitude of the regulatory bodies towards the enforcement of guidelines. Meanwhile, the PBOC conducted 1,708 law enforcement inspections2.
In this article, we will discuss how Hong Kong and Mainland China are catching up with global KYC standards; assess and compare KYC guidelines issued in Hong Kong and Mainland China; illustrate a business case of cross-border onboarding, as well as highlight the key pain points within the industry.
Hong Kong and Mainland China Moving Towards Global KYC standards
Over the years, both Hong Kong and Mainland China have taken various steps to maintain global KYC policy standards. Hong Kong has been a member of Financial Action Task Force (FATF) since 1991 and Mainland China since 2007. The FATF is an intergovernmental organization founded in 1989 to combat money laundering and is recognized as the global standard with over 37 members across the globe. As part of FATF, both Hong Kong and Mainland China are subject to regular inspections to ensure effective supervision on AML controls including KYC procedures. Recently, the FATF Mutual Evaluation on China‘s measures to combat money laundering and terrorist financing³ was released following onsite visits in July 2018. Furthermore, Hong Kong and Mainland China follow the standards set by the Wolfsberg group, an association of 13 global banks that aims to develop frameworks and guidelines for the effective management of financial crime.
Despite this, overseas branches of banks in Hong Kong and Mainland China have been penalized for breaching KYC regulatory requirements, indicating that some challenges still exist, especially at operational level.
Comparison Matrix : Hong Kong vs. Mainland China
For international banks that already operate in Hong Kong and plan to venture into the Mainland China market, as well as for the Chinese banks that aim to expand the wealth management and private bank business in Hong Kong, it is important to look at the differences in KYC policies between the two jurisdictions, to lay a path for compliant cross-border development of business. In the following discussion, we highlight the basic components of the KYC framework and and compare the level of maturity of regulatory requirements between Hong Kong and Mainland China ( fig. 1).
- Types of Due Diligence
According to the HKMA AML Guideline4, three types of due diligence are applicable to customers based on their risk ratings as identified from a risk assessment: Simplified Due Diligence (SDD), Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD). Under Mainland China Guidelines5, there is no clear statement on different types of due diligence.
- Beneficial Owner (BO)
The HKMA Guidelines define a BO as a natural person directly or indirectly owns more than 25 percent of the company's shares, 25 percent of voting rights or ultimate control over the customer, which can be a natural person, legal person or trust. Although Mainland China's definition of a BO is similar to Hong Kong's, according to the 2018 notice6, deficiencies were found by FATF regarding the ineffective arrangements for registering and retaining BO information and technical non-compliant in terms of transparency of BO of legal persons and legal arrangement.
- Politically Exposed Persons (PEPs)
The HKMA Guidelines define three types of PEPs: Foreign PEPs, Domestic PEPs and International Organization PEPs. It is also worth noting that Foreign PEPs refer to an individual who is or has been entrusted with a prominent public function in a place outside the People’s Republic of China (PRC), while Domestic PEPs play in a similar role within the PRC. The PBOC suggests similar definition for Foreign PEPs with that defined by the FATF, however, a Domestic PEP or any other type of PEP is not specified in the Mainland China Guidelines, as confirmed by FATF in its 2018 inspection.
- Reliance on due diligence performed by third parties (overseas subsidiaries within the Group)
From a group-level view, an on-shore subsidiary leveraging existing KYC information from an off-shore subsidiary is allowed, and this can largely ease up the onboarding process for the banks. Under the HKMA Guidelines, banks are allowed to rely on an (overseas) intermediary to perform any part of the due diligence process. In the case where group-wide policies are applied, the policies should comply with the local AML and KYC regulatory requirements to which the bank is subject. Under the Mainland China Guidelines, local banks are required to take certain precautions before establishing cooperation with third parties banks. Additionally, in the recent Notice on Enhancing Effort⁷, regulators explicitly added: Banks must not rely on third-party intermediaries from high-risk countries or regions8 to carry out any part of the due diligence process.
Focus on a Business Case: Cross Border Onboarding Across Greater Bay Area
As both Hong Kong and Mainland China are seen to be keeping up closely with the global KYC standards, cross-border onboarding or account opening is no longer a challenge. Permanent residents of Hong Kong can now open Mainland China bank accounts without leaving Hong Kong to complete the onboarding process. Banks are encouraged to take the initiative by providing cross-border financial services to strengthen financial connectivity within the Greater Bay Area9. Cross-border customer onboarding and account opening are major steps in connecting the financial markets of Hong Kong and Mainland China.
In March 2019, a Hong Kong bank announced the launch of a pilot scheme for Hong Kong permanent residents to open Mainland China personal bank accounts remotely. Hong Kong customers may now complete the Mainland China account opening procedure by attestation in one of the Hong Kong’s bank respective branches. In fact, for a few years now, many Chinese banks have been providing account opening witness services in which the wealth management customers in Mainland China can open Hong Kong bank accounts (in the local subsidiary bank of the Group) locally. Such connection is strongly welcomed by the regulators and the market. We foresee that the cross-border onboarding and account opening are of major importance and will continue to be a key step in supporting the implementation of the Greater Bay Area financial strategy.
On one hand, it is comparably easier for Hong Kong customers to open Mainland China accounts, as existing KYC information held by Hong Kong banks is sufficient to cover the onboarding requirements in Mainland China. On the other, the banks in Hong Kong might face some challenges in onboarding Mainland China customers (fig. 2).
General KYC Pain Points in the Industry
Beyond the specific challenges faced by Hong Kong banks in onboarding a Mainland China customer, the general pain points remain in identifying and verifying customers efficiently. The common pain points faced by most banks in onboarding include (but not limited to):
- Time consuming onboarding process due to redundant interaction for additional documents and information: the account opening process takes an average of more than 20 days – in the case of complex relationships, it is entirely possible for this period to take up to two or three months. Moreover, an average of eight to ten client interactions is required10.
- High error rate due to heavy reliance on manual processes.
- Lack of client data plausibility checks — especially cross-regulatory checks among KYC, FATCA, and MiFID due to manual processes and disconnected control methods.
- Increasing compliance cost due to the dynamic regulatory requirement that requires frequent change management and heavy reliance on human effort for decision making that requires hiring of subject matter experts.
- Absence of benchmark or standards for industry wide practices in between and across jurisdictions: banks still need to carefully tailor the group-level policies to meet the expectation from local regulators.
The KYC process is among one of the most complex, manual and unstructured processes presented in banks today. Costs and risks have risen significantly in recent years, driven by numerous new regulatory requirements that aim to strengthen AML controls.
However, banks that already have a strong presence in either Hong Kong or Mainland China can capitalize on the regulatory similarity discussed above to expand to the other market with cross-border onboarding. The main key points of KYC framework between Hong Kong and Mainland are summarised below (fig 3).
Given our industry experience in helping banks adopt compliant AML/KYC standards and our project management know-how, we can help you assess the existing KYC procedures, design a highly efficient target operating model for (cross-border) onboarding, as well as for client lifecycle management, and advise on KYC procedure design that delivers alignment with regulatory expectation in an efficient, effective and streamlined manner. The challenges and opportunities for AML controls were discussed in our previous article here.
We will be pleased to discuss further with you on your AML/KYC framework or bridging the operational gaps between Hong Kong and Mainland China for KYC compliance.