ISSA Compliance Rules Make Custodians Nervous

The International Securities Services Association adoption of financial crime compliance principles, could prove costly for custodian banks, who are nervous about the changes.


How anti-financial crime principles adopted by the International Securities Services Association, or ISSA, in September will play out in the global custody world has been the subject of much chatter at Sibos in Singapore.

The principles, which can be downloaded from ISSA’s homepage at , aim “to support the efforts of the global community of securities custodians and intermediaries to address the critical challenges posed by financial crime,” ISSA states.

However, up until now, the focus has been on cross-border payments processing and trade finance. The goal of the principles is to hammer out a clear global standard for the opening and maintenance of cross-border securities accounts.

One concern among global custodians is how the issue of recognition of beneficial ownership will play out.

ISSA’s paper announcing the principles states that they aim to provide guidance to securities custodians “on how to manage the risks that arise from layers of intermediation between securities issuers and ultimate beneficial owners.”

That guidance would almost certainly require greater transparency on ownership, which has implications beyond financial crime compliance.

In one example, the beneficial ownership issue came to life vividly during the Chinese stock market meltdown this summer.

The laws determining beneficial ownership in China are vague and untested in court, so much so that cross-border clearance under Shanghai-Hong Kong Stock Connect, which connects the two stock exchanges, skirts the issue by having block clearance in a proxy account identified as the Hong Kong exchange itself.

If adopted, ISSA’s principles would mean that Hong Kong and China would require a clearer definition of beneficial ownership in legal terms under Chinese law. That would eventually force a new structure in the way shares are cleared between China and Hong Kong.

A senior Swiss head of custody, who asked not to be identified, sees a risk to custodians if the ISSA principles are adopted to the letter.

“We may be providing a service for a single account for one client today, but under recognition of beneficial ownership we might have to manage that client’s business over hundreds of separate accounts,” he said. “It will be the end of us,” because of the cost, the custodian said, somewhat dramatically.

It is early days for the principles. Their adoption across markets is likely be less devastating than implied by the banker.

Mark Gem, head of compliance at Clearstream, a post-trade services provider owned by Deutsche Börse, said in a Sibos forum earlier this week that each market will adapt the principles into legislation at its own pace.

Like all conventions that are the basis of national law, the pace of adoption will undoubtedly be slow and prone to political obstacles.

However, if a major case were to arise involving a cross-border transaction into China hinging upon beneficial ownership, this could provide impetus for more stringent recognition under ISSA’s new rules.

Custodians are hardly foolhardy and see an increasing risk.