Moody’s Investors Service Hong Kong Ltd v Securities and Futures Commission
Court of Appeal
Civil Appeal No 103 of 2016
Lam V-P, Yuen and Kwan JJA
8 June 2017

Credit rating agency – definition of credit ratings – “red flag” report itself did not constitute credit rating – distinction between assessment of some (but not all) elements of credit risk and assessment of creditworthiness – report expressed opinion primarily on corporate governance and accounting risks only – report part and parcel of credit ratings business and fell within regulated activities under s. 193

M was part of a global credit rating agency network and was licensed under the Securities and Futures Ordinance (Cap. 571) (the “Ordinance”) to carry on Type 10 activity (ie, provide credit rating services) since June 2011. In July 2011, M published a document entitled “Red Flags for Emerging-Market Companies: A focus on China”, which examined various mainland Chinese issuers (the “Report”). It was distributed to subscribers and available for sale to the general public. M also issued a press release which stated that, “[M] highlights … governance and accounting risks prevalent when investing in fixed-income securities in the emerging markets. Through a framework of “Red Flags”, the Report focuses on transparency concerns and the general complexities associated with rapidly developing markets”. After publication of the Report, the share prices of more than half of the companies red-flagged dropped substantially. In a Decision Notice of 3 November 2014, the Securities and Futures Commission (the “SFC”) found that M failed to have the required procedural safeguards in place to ensure the integrity of the Report and the Report was materially misleading, confusing and inaccurate in several respects. M sought a review of the SFC’s decision. The Securities and Futures Appeals Tribunal (the “Tribunal”) found that M carried on Type 10 activities in the preparation and publication of the Report and there were substantive breaches of the Code of Conduct issued under s. 169 of the Ordinance. M appealed against that determination. “Credit ratings” is defined in Pt. 2 of Sch. 5 of the Ordinance as “opinions, expressed using a defined ranking system, primarily regarding the creditworthiness of – (a) a person other than an individual …”. Section 193 of the Ordinance defines misconduct as including “an act or omission relating to the carrying on of any regulated activities”.

Held, dismissing the appeal, that:

  • While the Tribunal erred in concluding that the Report itself constituted a credit rating, its decision was upheld on its alternative reasoning that misconduct could be established on the basis that the preparation and publication of the Report was part and parcel of the carrying on of the business of credit ratings by M and thus a Type 10 activity was engaged.
  • The Tribunal did not consider the notion of the Report being part and parcel of the credit rating in a vacuum. It was entitled to hold that even though the red flag framework was not part of the methodology in arriving at M’s credit ratings of a classic kind, the Report constituted additions and clarifications which were meant to be read together with such classic ratings and as such, the publication of the Report was an activity relating to the ratings within the meaning of s. 193 of the Ordinance. Further, the business of credit ratings encompassed clarifications or additions to existing ratings on an ongoing basis. This construction was consistent with the purposive interpretation of the statute and the proportionate interference with the freedom of expression.
  • Different credit rating agencies might have different baskets of factors. In determining whether an agency did provide credit rating services, the SFC or the Tribunal need not assess whether the factors or elements that such agency had taken into account were scientifically or statistically sound in terms of the final assessment. So long as the product was presented by way of an expression of opinions primarily regarding creditworthiness (using a defined ranking system), it would be caught by the statutory definition under Pt. 2 of Sch. 5 of the Ordinance. However, it was a different matter if the product was not presented as an expression of opinions primarily regarding creditworthiness and instead presented only as a discussion limited to one or two elements without expressing any opinion on the overall assessment of creditworthiness.
  • The Tribunal erred in failing to address the requirement of primacy in the statutory definition and the distinction between assessment of some (but not all) elements of credit risk and assessment of creditworthiness. The Report expressed an opinion primarily on corporate governance and accounting risks which were relevant but far from determinative of creditworthiness. M did not represent in the Report that it had adopted an alternative credit risk assessment approach based on governance and accounting risks alone and that the Report expressed an opinion primarily on an overall assessment of creditworthiness of the companies in the chart. M made it clear that although there was a degree of correlation for some non-property firms between lower ratings and larger numbers of red flags, the red flags did not represent a change in M’s rating methodologies (which encompassed other factors).

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