Recommended action plan

16. It should be stipulated in law that high level officials at the FSA can be removed only for cause with the reasons made public.

17. The most important measure to enhance Kazakhstan’s compliance with the Core Principles is the effective implementation of initiatives already underway. Key among these are:

• completion of the “launch phase” of the new supervisory agency, including implementing the new agreement with the NBK, filling staff vacancies, and finalizing the near-term management plan for banking supervision;

• achieving effective consolidated supervision; and

• implementation of the risk management requirements introduced in December 2003.

It is not yet clear whether the authorized complement of 300 staff members for the agency is appropriate. As an initial step, existing vacancies should be filled and an analysis undertaken as to whether this provides sufficient staff resources to implement fully adequate on-site and off-site supervision, including the new approach to financial conglomerates. The FSA’s budgetary autonomy must be ensured.

18. A legal foundation is now in place for consolidated supervision, prudential requirements were introduced on a group basis in 2003, and the FSA is working on its internal processes for the division responsible for conglomerate supervision to coordinate with the functional supervisors. While plans already exist to revise the existing regulations establishing prudential requirements for financial groups, the assessment team recommends a near-term focus on implementation of the existing framework before further legal revisions are considered in this area.

19. The assessment team recommends that in the near term the authorities focus scarce resources on evaluating the risk management policies and procedures of banks rather than on developing capital adequacy requirements for market risk. While larger banks require intensive attention due to their greater systemic importance, small banks also require attention as they are generally less well positioned to introduce the needed policies and systems. Technical assistance could be useful in helping to raise the overall standard of bank risk management practices, and also to develop the capacity of the FSA staff to understand and evaluate various market risks.

20. The assessment team recommends that the FSA focus special supervisory attention on any banks using extraordinary measures, such as offering merchandise or lottery prizes, to attract deposits. These could be indicative of emerging problems, and in the presence of interest rate ceilings, the FSA does not have at its disposal the direct indicator of banks paying rates well above market rates. The administrative limit on deposit rates should be removed.

21. One area where significant changes to the legal framework are still required is the prevention of the use of banks by criminal elements. An anti-money laundering law should be introduced, establishing a Financial Intelligence Unit (FIU), and the current bank secrecy provisions should accordingly be amended. Specific prudential guidelines for banks in conjunction with broader work on anti-money laundering/combating the financing of terrorism (AML/CFT) issues should be prepared. The FSA should be fully engaged with the Ministry of Justice, the Agency for the Fight Against Economic and Corruption Crimes, the NBK, and other agencies in the development and introduction of this law.

22. While outside the control of the FSA, it would be helpful if there was a broad review of fiscal policies affecting the financial sector. In particular, the assessment team is concerned about the distortionary effects of the limit on interest paid that banks can deduct from income for tax purposes. This has the perverse effect of causing higher loan rates as banks seek to earn an equivalent after-tax return for shareholders, and could ultimately weaken asset quality as borrowers bear the brunt of higher loan rates. The team also recommends that all specific provisions required to comply with the asset quality resolution should be deductible from income for tax purposes.

Authorities’ response

23. The authorities were broadly in agreement with the assessment, and found it unbiased and useful. The authorities have recently issued regulation on consolidated supervision and risk management, but agreed that insufficient time had passed to assess the implementation and effectiveness of these regulations. The authorities aim at bringing prudential regulation up to EU standards by 2007.

Principles for the regulator

Principle 1: The responsibilities of the regulator should be clear and objectively stated.

2000 Assessment: This principle was found to be largely observed.

2004 Observation: Effective January 1, 2004, the FSA became the single supervisor and regulator of the Kazakhstani financial services industry comprising banks, nonbank financial institutions, insurance companies, pension funds, and the securities market. The 2003 Presidential Decree on “Regulations on Financial Market and Financial Organizations Regulatory and Supervisory Authority”(Regulation), Securities Market Law (SML) (Article 3), and Financial Market and Financial Organizations Government Regulation and Supervision Act (FMRA) (Articles 3, 8–15) issued in 2003 provide clear objectives, functions, responsibilities, and authorities of the FSA. The Regulation defines the structure and organization of the FSA, describes the structure of the board, and the appointment of the members, and provides that the Board be the highest governing body of the FSA.

Principle 2: The regulator should be operationally independent and accountable in the exercise of its functions and powers.

2000 Assessment: This principle was deemed to be observed.

2004 Observation: The structures of the FSA and the board as described in the Regulation exhibit a high degree of operational independence. The FSA reports directly to and is accountable to the President of the Republic. The FSA is not a structural branch of the government and hence is not accountable to the latter. Neither is it accountable to or formally dependent on the National Bank of Kazakhstan (NBK), except that the NBK provides the budget and some logistical support. The majority (four members) of the seven board members are directly associated with the FSA. One representative each of the president’s office, the NBK, and the government are members of the board. Reports to the president are to be published. There are no supervisory fees collected by the FSA, which ensures commercial independence, but consideration is being given to collect such fees with a view not to ensure budgetary autonomy. Currently, the budget of the FSA is a part of a budget of the NBK, which has its own budget separate from that of the state. This separation ensures the staff a degree of independence from political influence, but the FSA’s full budgetary autonomy should be ensured. The members of the FSA board are “political servants,” and criteria for removal are specified in Article 26 of the Law on Public Service, but the president ultimately defines the base and the order of dismissal of political civil servants.

Principle 3: The regulator should have adequate powers, proper resources, and the capacity to perform its functions and exercise its powers.

2000 Assessment: This principle was found to be largely observed. The National Securities Commission (NSC) had the power to carry out surveillance of the market and to obtain relevant information from the NBK, ministries, state committees, and other bodies as well as issuers, market participants, and SROs including the Kazakhstan Stock Exchange (KASE). However, as noted under the section on Enforcement (Principles 8–10), it lacked adequate enforcement powers which was being addressed by amendments to the Administrative Code. The NSC could cooperate with foreign regulators by formally exchanging Memoranda of Understanding (MOU). The NSC was funded by the state budget with staff salaries paid by the NBK. The very thin market of corporate securities made it difficult to judge the adequacy of the NSC’s resources. However, its inability to file properly and make available issue information (i.e., prospectuses) for review by investors raised concerns. The assessment found that the introduction of an electronic filing and disclosure system should be considered.

2004 Observation: The FSA has a mandate to directly carry out surveillance of the market. It has power to obtain any relevant information from the NBK, ministries, state committees, and other bodies as well as issuers, market participants, SROs, stock exchanges, and over-the-counter (OTC) trading systems. The SML also empowers the FSA to cooperate with foreign regulators and coordinate activities to try to prevent violations in the securities market or other issues of mutual interest. Moreover, it is also required to file and make available issue information (i.e., prospectuses) for review by investors as suggested in the 2000 assessment. An electronic filing and disclosure system is being considered.

Currently, a staff of about 30 individuals in the FSA, (about 10 each in the on-site and off-site divisions), are designated to the supervision of the capital market participants (a group of about 120), each of whom reports at different frequencies. Included are 52 broker-dealers, 19 share registrars, 10 custodian banks, 10 asset management companies, 16 pension funds, 2 SROs, 1 stock exchange, and 1 central securities depositary. A disproportionate share of resources will increasingly be required in monitoring pension funds, owing to their rapid accumulation of funds as well as their social and fiscal importance. This could lead to a scarcity of resources when overseeing the rest of the securities market.

Principle 4: The regulator should adopt clear and consistent regulatory processes.

2000 Assessment: This principle was found to be largely observed.

2004 Observation: Powers to make or adopt substantive and procedural rules and regulations as well as to ensure that regulations and procedures are consistently applied, comprehensible, fair and equitable, are specified in the Regulation, SML, and FMRA. Extensive internal rules and operational procedures, codified in the new law formalize previously existing regulatory practice and procedures. Enforcement procedures also offer intermediate steps (e.g., request for explanation, warning, administrative action, penalties, etc.).

In practice, however, not all steps and procedures of the new laws are fully understood by market participants. Some do not see the difference between the new and the old regime, and understand it to be “business as usual.” The more sophisticated participants have noted various changes as well as inconsistencies arising particularly from holding more than one type of license. Moreover, bylaws and detailed procedural guidelines have not yet been issued to accompany the new laws creating some confusion in market participants. Although the FSA solicits views from the industry, it would further benefit from a continuous dialogue with market participants, in addition to responding to their questions and requests for clarifications in a timely manner.

Principle 5: The staff of the regulator should observe the highest professional standards including appropriate standards of confidentiality.

2000 Assessment: This principle was found to be observed.

2004 Observation: The staff of the FSA observes high professional standards, including those of confidentiality. As civil servants, the FSA staff has to meet requirements that have been established for administrative and political employees in Kazakhstan, including those of higher education and appropriate work experience. The guidelines for staff compensation established by the NBK provide competitive packages to attract specialists to the FSA.

All the employees sign employment contracts, which provide for due diligence and observance of confidentiality standards with respect to the information obtained during the course of exercising their powers and discharging their duties. Chapter 8 on Official and Commercial Secrecy and Chapter 19 on Information on Securities Market of the SML specify confidentiality requirements for FSA staff. Some countries have found it useful if staff disclose their financial interests to prevent conflicts of interest.

Principles for self-regulation

Principle 6: The regulatory regime should make appropriate use of Self-Regulatory Organizations (SROs) that exercise some direct oversight responsibility for their respective areas of competence, to the extent appropriate to the size and complexity of the markets.

2000 Assessment: This principle appears to have been largely observed. The Kazakhstan Stock Exchange was the only “statutory” SRO recognized under the Securities Markets Law (SML). Under an amendment to the SML, the KASE took over the self-regulatory responsibilities of the dormant broker-dealer association and regulated the off-the-exchange market. On the basis of the 1997 SRO Regulation, the NSC licensed the Association of Asset Management Companies (AAMC) with its seven members, and the Kazakhstan Registrars’ Association (KRKCA) with its 24 members, as SROs. Use of self-regulation is encouraged where an SRO exhibits “credible” competency. However, both the AAMC and the KRKCA appeared to lack capacity and credibility to perform this role.

2004 Observation: Mandatory participation of licensed professional market participants in their relevant SRO was previously recommended and subsequently introduced in the 2003 Principles for the Enforcement of Securities Regulation. According to the new SML, however, stock exchanges are no longer statutory SROs; the KASE—which is a joint stock company with the NBK (majority shareholder), banks and other participants as shareholders—has subsequently opted to cede even its nominal status as an SRO.

Another softening from the previous legislation is the fact that the FSA cannot license an SRO, but it can confer an SRO status in the event that at least half of the relevant market participants are members of the SRO. Previously, in compliance with the Regulation on Self-Regulatory Organizations of Securities Market Professional Participants (the SRO Regulation) issued in 1997, the NSC licensed the Association of Asset Management Companies (AAMC) and the Kazakhstan Registrars’ Association (KRKCA) as SROs. In practice, however, the KASE has—since the SML was passed—taken initiatives to be more responsive to the FSA’s needs. For instance, a market surveillance system is currently being developed.

The AAMC and the KRKCA continue to lack the capacity, credibility, and will to develop as SROs. One problem arises from the fact that the members and interests they represent are diverse. Another constraining factor arises from the fact that the SML empowers the FSA to demand information disclosure, and participants are averse to inspections by their competitors.

Principle 7: SROs should be subject to the oversight of the regulator and should observe standards of fairness and confidentiality when exercising powers and delegated responsibilities.

2000 Assessment: This principle was found to be materially non-observed. The KASE was the only functioning SRO and the AAMC had limited capacity and resources to act as an SRO.⁵ The KRKCA even appears to lack credible potential to be an SRO.⁶ The AAMC did not have a Code of Professional Conduct or credible capacity to impose such rules onto its members. The NSC did not provide specific competency requirements and did not conduct supervision of compliance with such requirements by the licensed SROs. Therefore, development of effective supervisory standards and procedures for SROs was not found. The proposed mandatory participation of licensed professional market participants in their relevant SRO would help enhance credibility of the SROs. But formal SRO status should be granted only against demonstrated capability and credibility, and that the process of granting the status (with transitional status) should be used to encourage potential SROs to strive to enhance their capability and credibility in specific self-regulatory functions. The assessment suggested that the NSC might wish to develop a comprehensive policy and strategy for authorization and supervision of SROs.

2004 Observation: As suggested by the 2000 assessment, Chapter 18 of the SML provides clear objectives, functions, responsibilities, powers and authorities of an SRO. The SML determines an SRO’s legal status, requirements and relationship with the regulatory authority. Under Article 94 of the SML, internal documents of an SRO shall include inspection and arbitrage regulations, rules and standards of professional activity and ethics of the member participants. Internal documents of an SRO are subject to approval by the FSA. The SML empowers the FSA to demand information. Chapter 8, Official and Commercial Secrecy and Chapter 19, Information on Securities Market, of the SML determine confidentiality standards for SRO staff.

In practice, however, the current SROs have very limited capacity and resources.⁷ If any reasonable competency requirements are now set up for authorization and supervision of an SRO, it is likely that neither the AAMC nor the KRKCA would qualify. Therefore, the previously recommended development of effective supervisory standards and procedures for SROs is still not in place.

Principles for the enforcement of securities regulation

Principle 8: The regulator should have comprehensive inspection, investigation and surveillance powers.

2000 Assessment: This principle was found to be largely observed.

2004 Observation: Under Chapter 20, Supervision of Securities Market Participants, (Articles 108–112) of the SML, the FMRA, and the Regulation provide inspection, investigation, and surveillance powers of the FSA with respect to various professional market participants, stock exchanges, over-the-counter (OTC) trade systems, SROs, issuers, and training centers. It is still difficult to police the market effectively, when it is so illiquid, and trades are arranged outside the exchange. Moreover, the KASE does not yet have its own market surveillance system.

Principle 9: The regulator should have comprehensive enforcement powers.

2000 Assessment: This principle was found to be materially non-observed. In the course of its regular inspections, the NSC found violations of the law and regulations. It had the power to suspend or revoke licenses of market participants and licensed SROs. In the case of issuers, the NSC can refuse, suspend or annul registration of an issue and disapprove a prospectus. However, it had no power to impose administrative sanctions directly. If any action fell within the definition of administrative offense under the Administrative Offenses Code, the NSC had to submit records of such offenses to the local Internal Affairs Department, before the offender could be called before the proper administrative body. NSC’s discretionary judgment seemed hampered by the way laws are defined and interpreted. At the time of the assessment, amendments to relevant law and regulations were being worked out to strengthen the NSC’s enforcement power.

2004 Observation: Significant strides have been made in the regulator’s enforcement power, which enable it to impose administrative sanctions including financial penalties. In case of offenses by professional market participants, the FSA is empowered to suspend or revoke licenses, impose penalties, recall approval of senior managers and reexamine certified specialists. Revocation of a license requires a six month suspension and approval by the board. In the case of issuers, the FSA can refuse registration of the issue, suspend placement, and disapprove reports on placement and maturity. All sanctions imposed by the FSA can be challenged only through the court. Additionally, these sanctions are to be publicized by the FSA. If any action falls within the definition of administrative offense under the Administrative Offenses Code, the FSA must submit records of such offenses to the local Internal Affairs Department to be filed in the administrative office’s records so that the offender can be called to the proper administrative body or appeal to other government authorities (General Prosecutor’s Office, Tax committee, Ministry of Justice and Ministry of Internal Affairs). The FSA can refer matters to criminal authorities.

Principle 10: The regulatory system should ensure an effective and credible use of inspection, investigation, surveillance and enforcement powers and implementation of an effective compliance program.

2000 Assessment: This principle was found to be materially non-observed. In September 1999, the NSC adopted instructions on conducting inspections on: (i) the securities market’s subjects to check validity of their licenses and observance of the effective legislation; and (ii) issuers. These instructions also provided sanctions for certain offenses. All sanctions imposed by the NSC can be challenged only through the court. The NSC conducts periodic, routine inspections as well as causal inspections whose results are reflected in their quarterly and annual reports. As stipulated by regulation, the annual reports are published. In reality, however, it appeared that the NSC does not sanction wrongdoing by issuers, for example, unless complaints are filed by investors. The reluctance of joint stock companies to go public and strict sanctions against issuers appeared to undermine the market changes to develop, making the NSC reluctant to impose sanctions. The assessment noted that a new law to protect small businesses appeared to prevent the NSC from suspending or revoking a small enterprise’s license since many broker-dealers and most registrars were small enterprises.

2004 Observation: Instructions determine the procedures for conducting inspections, as noted in the 2000 assessment. The FSA provides sanctions for certain offenses; all sanctions imposed by the FSA can be challenged only through court. The FSA can conduct periodic, routine inspections as well as causal inspections and joint inspections with other government authorities (e.g., tax authorities, internal affairs authorities, prosecutors).

While the environment is still one of reluctance on the part of joint stock companies to go public, the FSA is hesitant to impose strict sanctions against issuers for the same reasons as noted in the 2000 assessment. Moreover, the former law’s protection of small businesses through the prevention of issuance of sanctions against broker-dealers and registrars—most of them were small enterprises—has effectively been superseded by the new law’s high capitalization requirements.

The FSA now can sanction wrongdoing if complaints are filed by investors, the stock exchange, registrars and nominal holders (not beneficial owners), and additionally if the registration and approval process reveals violations. In practice, however, surveillance by market participants is severely lacking and no violations are expected to be reported by market participants.

Principles for cooperation in regulation

Principle 11: The regulator should have authority to share both public and nonpublic information with domestic and foreign counterparts.

2000 Assessment: This principle was found to be largely observed.

2004 Observation: The FMRA, the Regulation, and Clause 3 of Article 43 of the SML provide that the FSA has a right to request and receive information required for its activity in the securities market from government authorities, issuers, licensees and SROs. The SML determines what information is to be disclosed publicly by the FSA. Chapters 8 on Official and Commercial Secrecy and 19 on Information on Securities Market of the SML determine the information, which is not a subject of disclosure. The FSA is empowered to cooperate with foreign regulators, share information, and coordinate activities in the area of prevention and avoidance of violations in the securities market or in other issues of mutual interest. Limitations existing in the previous law appear to have been removed, since at present even information determined as official or a commercial secret can be disclosed to a foreign regulatory authority in accordance with a ratified agreement. Other nonpublic information can be disclosed without any agreement.

Principle 12: Regulators should establish information sharing mechanisms that set out when and how they will share both public and nonpublic information with their domestic and foreign counterparts.

2000 Assessment: This principle was found to be largely observed.

2004 Observation: The FSA is required by new Regulation to disclose public information, including the FSA’s rules and regulations, information on issuers and issues, sanctions enforced, and information on licensees. Currently, this information is disclosed on the FSA’s website (www.nsc.kz). Some progress appears to have been made in establishing mechanisms to share nonpublic information with domestic and foreign regulators. Information determined as official or a commercial secret can be disclosed to a foreign regulatory authority in accordance with the agreement ratified; other nonpublic information can be disclosed upon request. Information to the government authorities is to be disclosed upon receipt of a request in accordance with government authorities’ rules. Currently, the FSA is preparing an MOU for ratification procedures. MOUs are not yet in place with foreign regulators, but the FSA collaborates with the Russian authorities.

Principle 13: The regulatory system should allow for assistance to be provided to foreign regulators who need to make inquires in the discharge of their functions and exercise of their powers.

2000 Assessment: This principle was found to be materially non-observed. Although the NSC was allowed to cooperate with foreign regulators within the above-stated limitations, they did not appear to have established procedures for providing assistance in: (i) obtaining voluntary cooperation from those who may have information about the subject of an inquiry; (ii) obtaining documents, statements or oral testimony; (iii) providing information on regulatory process; and (iv) obtaining court orders. (See also Principle 11.)

2004 Observation: Limitations to cooperate with foreign regulators have been eased. The FSA is empowered to share information, cooperate with foreign regulators and coordinate activities in the field of prevention and avoidance of violations in the securities market or in any other issue of mutual interest. Information determined to be official or a commercial secret can be disclosed to a foreign regulatory authority in accordance with the agreement ratified; other nonpublic information can be disclosed upon request. Procedures still need to be clarified for providing assistance in the four areas cited in the 2000 assessment.

Principles for issuers

Principle 14: There should be full, timely and accurate disclosure of financial results and other information that is material to investors’ decisions.

2000 Assessment: This principle was found to be materially non-observed. The Securities Market Law provided for full and fair disclosure of information about securities issue and issuer, however, periodic disclosure was required only for public joint stock companies, of which there were only a few dozen. Most were not open public joint stock companies and, therefore, were not required to provide periodic disclosure. The 2000 assessment recommended prudentially formulated disclosure requirements regarding management conflicts of interest. The NSC was strongly encouraged to create an electronic filing and disclosure system for registered offerings and periodically reported information. Short comings included anomalies in the registration requirements for securities, loopholes in the rules to exempt closed offerings of joint stock company shares from registration, and the absence of a law restricting resale of unregistered issues or requiring periodic reporting unless joint stock company shares were involved.

2004 Observation: Articles 101–107 in Chapter 19 of the SML provide for full and fair disclosure of information about a securities issue and issuer. The Shares Issue Rules and Bonds Issue Rules adopted in 2003 require registration and public disclosure of changes in significant items of prospectuses. These rules significantly widen the information to be disclosed in a prospectus, including information on capitalization and indebtedness, observation of risk factors, the history and development of the company, operating results, trend information, information on directors and senior management, dividends and paying agent, patents, etc. Periodic disclosure is required for listed companies and joint stock companies, all of which are now considered public, since the new joint stock company act no longer allows for closed joint stock companies. Hence, loopholes arising from earlier rules to exempt closed offering of joint stock company shares from registration are avoided. The minimum capital requirement of joint stock companies has been made higher and smaller companies that could in the past be considered joint stock companies are now limited liability companies.

Electronic filing and disclosure system for registered offerings and periodically reported information is under consideration.

Principle 15: Holders of securities in a company should be treated in a fair and equitable manner.

2000 Assessment: This principle was found to be materially non-observed. The Joint Stock Company Act provided that a common share would afford each shareholder the same rights as provided to other owners of common shares and that voting at a general shareholders’ meeting would be performed on the basis of “one share–one vote.” The NSC could discover breaches of the articles by inspection and restore shareholders’ rights and interests. The Securities Market Law included insider trading provisions. However, civil procedures did not appear to provide for class action. While the Joint Stock Company Act provided for tender offers, an NSC rule required broker-dealers to conduct securities transactions only through the authorized stock exchange (KASE). The 2000 assessment called for changes to the rule or stock exchange procedures to accommodate tender offers. The Joint Stock Company Act provided for cumulative voting to elect minority directors; however, this was made ineffective by the rule of removal of directors by a simple majority, effectively ensuring that majority shareholders could put directors of their choice on the board.

2004 Observation: The new Joint Stock Company Act maintains that a common share shall provide each shareholder with the same amount of rights as is provided for other owners of common shares and that voting at a general shareholders’ meeting shall be performed on the basis of “one share-one vote.” The FSA can discover breaches of the articles by inspection and restore shareholders’ rights and interests. The Financial Services Customer Protection Department of the FSA does provide customer and investors with qualified consultation and informs the relevant Inspecting Division. The Joint Stock Company Act also provides for cumulative voting to elect minority directors and the problem of majority voting limiting minority directors may have been removed.

Principle 16: Accounting and auditing standards should be of a high and internationally acceptable quality.

2000 Assessment: This principle was found to be materially non-observed. Twenty-nine accounting standards based on IAS had been adopted. Ironically, these seem to be creating a greater incentive to hide profit and avoid taxes. International Auditing Standards had not been adopted, although they were in the final stage of consideration.

2004 Observation: Financial organizations in Kazakhstan have been implementing International Accounting Standards (IAS, now International Financial Reporting Standards, IFRS) from 2003, while nonfinancial entities will start IAS implementation in January 2005. In 2003, Kazakhstan Auditing Standards were recognized to be invalid, and International Standards on Auditing (ISA) have since been applied. In practice, however, only the larger institutions are able to apply IFRS. The smaller ones perceive that they have been given a reprieve, since there is a migration schedule in place for transitioning to IFRS. Moreover, the tax office will also require some transitioning time. Furthermore, “marking-to-market” is not currently particularly meaningful, since the market is illiquid.

Principles for collective investment schemes

Principle 17: The regulatory system should set standards for the eligibility and the regulation of those who wish to market or operate a collective investment scheme.

2000 Assessment: This principle was found to be largely observed.

2004 Observation: Only asset management companies can manage an investment fund’s assets. Therefore, operators of collective investment schemes are subject to regulation, supervision and enforcement by the FSA.

Principle 18: The regulatory system should provide for rules governing the legal form and structure of collective investment schemes and the segregation and protection of client assets.

2000 Assessment: This principle was found to be materially non-observed. Although the Investment Fund Act provided a legal framework and structures for mutual funds, the definition of “affiliated persons” and conflicts of interest in related party transactions was too narrowly defined. Considering the size, growth and social importance of pension funds, which are managed by asset management companies licensed and regulated by the NSC, the inadequate control of potential principal-agent problems seemed to generate a major potential vulnerability for the economy in medium-term. The Pension Act has broadened the definition of affiliated persons to include “anyone with a right directly or indirectly to influence the decisions of the other, even if the right arises only by informal agreement.” Under the Pension Act, the custodian monitors compliance of fund investments with the asset allocation rules applicable with them. The assessment recommended that the Investment Fund Act adopt similar provisions. Clearly, the custodian’s affiliation with the asset management company should be controlled appropriately.

2004 Observation: A new Investment Funds Act was introduced to Parliament recently (January 8, 2004). In practice, however, no new investment fund has been operating in the securities market since December, 2000. For instance, banks that act as investment managers of pension funds are required to use another bank as the custodian bank.

Principle 19: Regulation should require disclosure, as set forth under the principles for issuers, which is necessary to evaluate the suitability of a collective investment scheme for a particular investor and the value of the investor’s interest in the scheme.

2000 Assessment: This principle was found to be materially non-observed. The suitability requirement was provided in Investment Fund Act. As fiduciary organizations, however, collective investment schemes should be required to avoid conflict-of-interest transactions; when these exist, the collective investment schemes must at least be required to disclose the transactions. Both investment and pension funds must be organized as joint stock companies subject to certain disclosure and shareholder approval requirements for “conflict-of-interest transactions.” The definition in law of conflict-of-interest transactions seemed to include those among blood relatives. In the case of pensions, shareholder approval of conflict-of-interest transactions would provide little protection, since the pension shareholders were the sponsors not the beneficiaries under the Pension Act. In the case of investment funds, the Investment Fund Act, specifically designed to regulate the vehicles, may be used to over-rule the Joint Stock Company Act, potentially creating a situation where conflicts would be less tightly controlled in a fiduciary organization than in an ordinary commercial entity.

2004 Observation: The new Investment Funds Act was introduced to Parliament recently (January 8, 2004). In practice, however, no investment fund has been operating in the securities market since December, 2000. Conflict of interest issues pointed out in the previous FSAP, have been addressed.

Principle 20: Regulation should ensure that there is a proper and disclosed basis for asset valuation and the pricing and the redemption of units in a collective investment scheme.

2000 Assessment: This principle was found to be materially non-observed. Valuation of the collective investment schemes’ portfolios in an illiquid market was and is difficult. At the time of the assessment, a committee, under the auspices of the NSC, composed of market professionals was working on establishing a calculation methodology. In establishing a methodology, provision for when it can be revised in response to changes in the market environment (i.e., introduction of new instruments, increase of liquidity, etc.) would be needed as well. Changes in methodology tend to generate a systemic impact on the value of investment portfolios across collective investment schemes that can cause a panic in the market.

2004 Observation: A Valuation Committee was established in 2002 to evaluate domestic securities and to develop a calculation methodology for pension asset management companies. The draft Investment Funds Act is envisioned to provide requirements for unified asset valuation.

Principles for market intermediaries

Principle 21: Regulation should provide for minimum entry standards for market intermediaries.

2000 Assessment: The principle was found to be largely observed.

2004 Observation: The SML provides most of the basic conditions for authorizing market intermediary business (e.g., competence, capital, recordkeeping, segregation of customer assets, conflicts of interest, best execution, etc.), licensee’s preliminary requirements, and enforcement procedures. More specific requirements regarding internal control procedures to assure compliance with the laws and regulations also have been added. A licensee’s preliminary requirements, including capitalization, stockholders’ requirements, requirements for relevant certified specialists, prudential ratios, technical equipment, internal documents and structure requirements, relevant SRO are to be monitored constantly. Certain information provided in a licensing application has to be reported if it changes after the license is granted. There are also provisions for de-licensing, if changes occur that would disqualify the firm.

Principle 22: There should be initial and ongoing capital and other prudential requirements for market intermediaries that reflect the risks that the intermediaries undertake.

2000 Assessment: The principle was found to be largely observed.

2004 Observation: The initial minimum capital requirements and prudential ratios are imposed for market intermediaries, stock exchanges, the CSD, and OTC trading systems. The capital requirements and prudential ratios are the subject of permanent monitoring. Capital requirements include both on-balance sheet items and off-balance transactions for commercial banks and asset management companies, including pension assets management. For the rest of the licensees, off-balance sheet transactions are not included in a calculation of capital adequacy. Prudential ratios include liquidity requirements, own investments, exposure to one issuer, and the like. Currently, professional intermediaries are subjects of supervision on consolidated basis. The implementation of consolidated supervision, however, can be further improved, which has been facilitated by integrated supervision, and is envisaged by the FSA. No changes in the reporting frequency have been instituted. In the future, a more risk-based approach may be considered.

Principle 23: Market intermediaries should be required to comply with standards for internal organization and operational conduct that aim to protect the interests of clients, ensure proper management of risk, and under which management of the intermediary accepts primary responsibility for these matters.

2000 Assessment: The principle was found to be non-observed. As noted under Principle 21 above, there were few clear requirements for internal control procedures to assure compliance with the laws and regulations. A code of conduct did not exist, although a KASE initiative on this was expected. There did not appear to be specific requirements of risk management capacity and procedures, aside from that of minimum excess capital.

2004 Observation: Professional intermediaries should have internal procedures and control order (Regulation and Internal Rules) approved by the FSA. All changes to the internal procedures and control order (Regulation and Internal Rules) of market intermediaries must by approved by the FSA. Licensing Rules include special requirements for technical and IT adequacy for each type of professional intermediary. The FSA is also responsible for formal attestation of specialists. Monitoring and inspecting procedures also involve control of qualification requirements, criteria of financial stability (prudential norms), and internal procedures compliance. Pursuant to the Broker/Dealer Activity Rules, the interest of the client is previous in case of conflict of interests, and the “best execution” method is imposed. All market intermediaries are required to: observe high standards of integrity and fair dealing, act with due care and diligence, act in a best interest of the client, disclose to the client where there is a potential conflict of interest, and treat all clients, in case of conflict of interest, the same. In order for banks to avoid conflicts of interest between its function as a broker/dealer and the interests of clients, which have entrusted their securities to the bank on the basis of a custody agreement, a “Chinese wall” has been set up. This structure means that all of a bank’s departments engaged in custodial and broker/dealer activities should work separately and maintain confidentiality. In case of offenses by professional market participants, the FSA is empowered to impose penalties, recall approval of senior managers and reexamine certified specialists.

A Code of Conduct (Ethic Code) for Market Intermediaries and Qualified Specialists (this code is in the form of recommendations and does not have legislative power) was established at the Securities Market Experts Committee of the NBK in 2002. The Code determines standards of fair activity, confidentiality, and principles of fair competition. The Code of Conduct established by KASE is mandatory for broker-dealers that members of the KASE.

All market participants are obliged to enter into written contracts with clients. Typical contracts and orders have to be approved by the FSA. General requirements for contractual relations are determined by the Civil Code of Kazakhstan.

Independent registrars, depositories, and custodians have special technical requirements for keeping and updating information. Every customer of financial service has right to sue market intermediaries. Moreover, Financial Services Customer Protection Department of the FSA provides customer and investors with qualified consultation and informs relevant Inspecting Division.

While there are requirements for internal control procedures to assure compliance with the laws and regulations, as well as requirement of risk management capacity and procedures aside from the requirement to meet minimum excess capital, participants do not perceive any significant changes yet. Increasing awareness and understanding of these procedures through workshops and campaigns is required.

Principle 24: There should be procedures for dealing with the failure of a market intermediary in order to minimize damage and loss to investors and contain systemic risk.

2000 Assessment: The principle was found to be non-observed. There did not seem to be any established procedures for dealing with the failure of a market intermediary or an insurance scheme to protect assets of investors dealing with a failed market intermediary.

2004 Observation: This principle is not directly regulated by effective legislation. Only withdrawal of the licensing procedure is established. In the case of bankruptcy, only the bankrupt institution’s assets belong to creditor, except assets of clients. The following part relates to the self-assessment: “The FSA places information on the official sanctions made to the intermediaries on the website. Market intermediaries required to inform clients about own violation of prudential norms or financial stability criteria and sanctions of the FSA.” The SML empowers the FSA to inspect and monitor liquidation and reorganization procedures of licensees; the FSA formed the Financial Organizations Liquidation Department to control the liquidation process. An insurance scheme to protect assets of investors dealing with a failed market intermediary does not yet exist.

Principles for the secondary market

Principle 25: The establishment of trading systems including securities exchanges should be subject to regulatory authorization and oversight.

2000 Assessment: The principle was found to be observed.

2004 Observation: Stock exchanges and OTC trading systems as licensees are subject to supervision, licensing, and prudential regulation. The FSA oversees the KASE and conducts close surveillance of the OTC trade system. The Regulations of the KASE (including operational rules, calculation methodologies, listing requirements, procedural rules, etc.) have to be approved by the FSA. The SML provides for authorization by the FSA of a stock exchange as a noncommercial organization created by professional market participants. The SML directly provides for functions, membership, participants management, governance, income, transactions, obligations of listed issuers, market information dissemination, and liability and termination of an organized market. The SML also provides for authorization for operation of the OTC market. The concept of the OTC market reflected in the Act remains as it was in 2000.

Principle 26: There should be ongoing regulatory supervision of exchanges and trading systems which should aim to ensure that the integrity of trading is maintained through fair and equitable rules that strike an appropriate balance between the demands of different market participants.

2000 Assessment: The principle was found to be observed.

2004 Observation: The NBK has majority ownership of KASE and the FSA has authority to suspend securities trades. KASE’s internal documents are subject to FSA approval. Stock exchange members have equal rights and responsibilities. Stock exchanges are required to form an internal control department. Trade systems, including OTC, are required to submit weekly, quarterly, and annual reports. The FSA also conducts close surveillance of the OTC market. Means to supervise trading systems include handling of error accounts, trade allocation of bunched or block orders, handling of unmatched trades, modification of orders entered into the system, technical standards, requirements for maintaining records and reporting failed trades, procedures related to operational failures, recordkeeping and retention, procedures for holding client funds and securities (financial integrity).

In practice, however, the illiquidity of the market and lack of order interaction makes market surveillance superfluous at the moment.

Principle 27: Regulation should promote transparency of trading.

2000 Assessment: The principle was found to be largely observed.

2004 Observation: This principle is observed in a sense that the regulation does try to promote transparency. However, the market is not transparent enough due to illiquidity and lack of order inter-action. For bonds, the existence of a five-minute window before orders are matched, allows some transparency of market prices. For shares, however, trades are still pre-arranged outside the exchange and only transacted on the exchange; and for those, the KASE remains a de facto information reporting center rather than an exchange.

The open trades’ method is the basic method of trades on the stock exchange. The following methods of trades may also be applied: method of direct transactions, method of discrete trades (Frankfurt method of trades, Dutch method of trades, English method of trades, method of fixing). Algorithms of all applied methods of trades aim to achieve fair trades on equal conditions for all participants. The methods of trades are subject to approval by the FSA.

The transactions with listed securities are required to be carried out through the CSD using delivery-versus-payment (DVP). The accounts under the transactions correspond to the recommendations of the “Group of 30,” i.e. the final settlement occurs not later than on the third working day from the date of the transactions.

The FSA expects the stock exchange to provide necessary and sufficient pre- and post-trade transparency to support reliable price information. Stock exchanges are expected to have arrangements that deliver this information on an equitable basis to all market members. Pre-trade information contains items of information on bids and offers for each transaction, both in the primary and the secondary market. Post-trade information contains information on the last sale price and on the volume of transactions. All stock exchange members have accesses to this information. The basic task of the stock exchange is to deliver pre- and post-trade information on an equitable basis to all market members.

Principle 28: Regulation should be designed to detect and deter manipulation and other unfair trading practices.

2000 Assessment: This principle was found to be materially non-observed. The Securities Market Law required organized and OTC markets as SROs, to establish a list of violations against which the markets would impose fines. However, the illiquid market and the nature of trading made detection of unfair trading practices difficult. In fact, the KASE did not have a market surveillance or stock watch system. The requirement to trade all open joint stock company shares through the KASE represented a step toward enhancing not only the liquidity of the KASE and the effectiveness of the price discovery but also market surveillance.

2004 Observation: The FSA has a new unit to detect speculation and manipulation, but it was established recently and is untested. The current illiquid market and the nature of trading demand continue to make detection of unfair trading practices difficult. The KASE still does not have a market surveillance or stock watch system Current legislation prohibits market manipulation, market cornering, misleading statements, insider trading, front running, and other fraudulent or deceptive conduct, which may distort the price discovery system, distort prices, and unfairly disadvantage investors. Manipulation and other unfair trading practices are prohibited by civil legislation, criminal law, administrative law, and market rules of Kazakhstan. The Code of Conduct of market intermediaries and certified specialists provides for the basic types of unfair transactions. The establishment of standby mode in buy/sell share order satisfaction in the trading system of the KASE gives an opportunity to KASE to stop unfair securities transactions.

The order of recognition of the unfair transactions and price manipulation is currently being developed by the FSA and will be adopted in the first quarter of 2004. Theoretically, means to identify and address disorderly trading conditions (market surveillance) are currently failing to: review for wash trading, review for price manipulation, review for congestion and cornering, review for unusual price or volume movement, and communication of price sensitive information to the market.

Principle 29: Regulation should aim to ensure the proper management of large exposure, default risk and market disruption.

2000 Assessment: This principle was found to be largely observed.

2004 Observation: With the current illiquid market, trades are settled on a gross DVP basis. Hence, there are no counterparty credit risk exposures to manage. Accordingly, a settlement guarantee fund does not exist. OTC trades, however, are arranged bilaterally, and are possible to settle on a DVP basis. There is a transactions confirmation system, and information technology (IT) and software requirements were enhanced to avoid market disruption. As the market develops, additional systems will need to be put in place, and the solvency structure re-examined.

Principle 30: Systems for clearing and settlement of securities transactions should be subject to regulatory oversight, and designed to ensure that they are fair, effective and efficient and that they reduce systemic risk.

2000 Assessment: This principle was found to be largely observed.

2004 Observation: The FSA oversees the operation of the CDS. NBK Resolution no. 64 raised the minimal size of own capital for the CDS. As the market develops, monitoring may need to be increased and a greater sensitivity developed for potential vulnerabilities to systemic risk. The CDS effects gross DVP based settlement of securities trades and takes no settlement risk. The Bankruptcy Act reflects some impediments in effecting netting, for example, the pledge and liquidation of collateral.

Summary of the 2000 FSAP assessment

29. The 2000 FSAP assessed Kazakhstan’s observance of the IAIS Principles. Principles related to licensing, including fit and proper; capital adequacy; solvency; and confidentiality were fully observed. Kazakhstan was found to broadly observe requirements on technical provisions, financial reporting, on-site inspections, and sanctions. Kazakhstan was found to partially observe principles with respect to organization, assets, liabilities, and market conduct. Principles related to changes in control, corporate governance, and internal controls were not observed. Three principles were not relevant at the time (2.3, 9 and 15), and there was insufficient information to assess three other principles (7.3, 10, and 16). Compliance was expected to improve with the passage of new insurance legislation that would clarify the role of the supervisor regarding issuance of licenses; enforcement powers, particularly with respect to ownership and transfer of control with insurance companies; as well as rules for corporate governance.

30. The 2000 FSAP recommended a radical reform of supervision capacity and practices. The insurance sector needed to modernize its accounting an auditing system in order to facilitate effective monitoring of the performance of insurance companies. Moreover, it was noted that the EU approach to solvency supervision demands new skills and a more qualified and professional staff of supervisors should be recruited and trained. It would be helpful to have training opportunities for supervisory personnel on such topics as accounting, reserving and new product opportunities. Company managers could also participate in this training.

31. On-site inspections tended to focus on compliance with the legal requirements. Sound practice would suggest examining how the company is managed, its business practices, its financial controls, and whether other important characteristics of a soundly operated institution are in place, such as how the company markets its products, and whether it has an explicit business strategy.

32. The principal recommendations made in the FSAP 2000 for the insurance sector were that Kazakhstan should: (i) pass new insurance legislation in line with modern international practices, (ii) prescribe and develop accounting principles and auditing and financial reporting, (iii) develop an actuarial profession, and (iv) upgrade supervision.

Summary of the 2004 update⁸

33. Since the 2000 FSAP, the authorities have made good progress in updating insurance legislation. The new legislation is well articulated, but is a bit too ambitious for the currently limited resources available to the Agency of the Republic of Kazakhstan on Regulation and Supervision of Financial Markets and Financial Organizations’ (FSA’s) Insurance Department and within the industry.

34. Implementation and enforcement practices need to be strengthened. The 2000 FSAP suggested development of an actuarial profession and an upgrade of supervision, but these recommendations have been difficult to carry out by the supervisory body and the insurance industry. However, the Society of Kazakhstani Actuaries, which was established in 2001-02, currently has 50 members, of whom 30 have an actuary license. It is unclear to what extent there is sufficient implementation capacity in the industry and the FSA to fully meet the legislative requirements. The FSA’s enforcement track record is also limited, and given the recent changes in the regulatory organization, cannot be verified.

35. The FSA’s insurance department is understaffed and has no formal training program. This limits the range and quality of the services it can render to the industry. The role of actuaries becomes ever more important as the industry grows to enable better measurements of risks and to establish a basis for pricing products. This may need to be reflected in the law. At present, only four actuaries are available in the FSA to service both insurance and pension interests.

36. The FSA should work together with the associations and brokers to create relationships between insurers and policyholders and insurers and brokers. Among other things, the method for handling of claims and complaints would benefit.

37. The insurance industry should over time strive to raise its rate of insurance penetration as the economy grows. This would put Kazakhstan on a par with other Central and Eastern Europe markets. To achieve this objective, several major policy changes are needed. In particular, the industry should establish a reliable database to determine reserve requirements and tariffs for existing products, and, before introducing additional compulsory insurance products, it should ensure preconditions to determine appropriate reserve requirements and tariffs should be in place.

Update of IAIS principles

Principle 1: Organization

The insurance supervisory body of a jurisdiction must be organized so that it is able to accomplish its primary task, that is, to maintain efficient, fair, safe, and stable insurance markets for the benefit and protection of policyholders. It should be able at any time to carry out this task efficiently in accordance with the IAIS Principles. In particular:

• the supervisor should be operationally independent and accountable in the exercise of its functions and powers;

• the supervisor should have adequate powers, proper resources and staff, and the capacity to perform its functions, and exercise its powers;

• the supervisor should adopt clear, transparent, and consistent regulatory and supervisory processes;

• the decision-making lines of the supervisory body should be structured;

• the staff of the supervisor should observe the highest professional standards, including appropriate standards of confidentiality; and

• the supervisor should establish an employment system to hire, train, and maintain staff with the highest professional standards.

2000 Assessment: This principle was found to be partially observed. Updating existing legislation was deemed to be needed before the authority and powers of the supervisor could be rated completely satisfactory.

2004 Observation: At this juncture, obsolete legislation has been replaced producing the following changes:

The new law “On Insurance Activity,” which is currently in force, was adopted at end-2000. This law complies with international principles and standards of insurance supervision. The law obtained a high degree of recognition by international experts and organizations. It gives sufficient powers to regulate the activity of all insurance and reinsurance companies, insurance brokers, and other professional participants of insurance market. In accordance with this law, more than 30 regulations were passed by the FSA. In addition, the Civil Code contains articles on insurance, the law on joint stock companies, and other laws regulate activities of insurance companies and other participants in the insurance market being legal entities.

On January 1, 2004, the FSA was established as a new independent financial supervision authority. Financial sector supervision, including of insurance companies and pension funds, was moved to the new agency from National Bank of the Republic of Kazakhstan (NBK). The FSA is accountable to the President of Republic of Kazakhstan. The FSA is funded by the NBK, and its budget is thus separate from the state budget. However, the FSA’s budgetary autonomy should be ensured. All supervisors are covered by health and accident insurance bought for the employer’s account. Currently, a staff of about 27 in the FSA, (about 10 in the on-site, 11 in the off-site, 4 in the actuary divisions), are designated to the supervision of the insurance sector. The Insurance Department has no formal training program. Due to the FSA’s short supervisory history, it is premature to assess the supervisory and institutional capacity, the implementation and enforcement track record, and its governance.

Principle 2(1): Licensing

Companies wishing to underwrite insurance in the domestic insurance market should be licensed. Where the insurance supervisor has authority to grant a license, the supervisor:

• in granting a license, should assess the suitability of owners, directors, and/or senior management, and the soundness of the business plan, which could include pro forma financial statements, a capital plan, and projected solvency margins; and

• in permitting access to the domestic market, may choose to rely on the work carried out by an insurance supervisor in another jurisdiction, provided the prudential rules of the two jurisdictions are broadly equivalent.

2000 Assessment: The principle was found to be fully observed.

2004 Observation: No licenses were issued since the NBK became responsible for insurance supervision. In anticipation of the establishment of a new independent agency, it was necessary to establish, under the new legislation, licensing procedures. A special regulation has been passed, which contains requirements as to the documents and information required in the licensing procedure. The regulations regarding the review of license applications appear to be in compliance with this principle.

Principle 2(2): Licensing—Fit and Proper

2000 Assessment: This principle was found to be fully observed.

2004 Observation: Supervisors are expected to apply “fit and proper” tests to major shareholders and managers; to request a business plan; pro forma financials; and projections of solvency conditions.

Principle 2(3): Licensing—Reliance on other Jurisdictions

2000 Assessment: This principle was found to be not applicable.

2004 Observation: There is a special requirement in the new legislation that the founder of an insurance or reinsurance organization, who is a nonresident of the Republic of Kazakhstan, must submit a document from the appropriate insurance supervision agency of its own country. This document must confirm that the founder is permitted to participate in the charter capital of an insurance or reinsurance organization, which is a resident in Kazakhstan; or a statement indicating that no such permit is required under the legislation of the relevant country.

Principle 3: Changes of control

The insurance supervisor should review changes in control of companies that are licensed in its jurisdiction. The insurance supervisor should establish clear requirements to be met when a change in control occurs. These may be the same as, or similar to, the requirements that apply when granting a license. In particular, the insurance supervisor should:

• require the purchaser or the licensed insurance company to provide notification of the change in control and/or seek approval of the proposed change; and

• establish criteria to assess the appropriateness of the change, which could include the assessment of the suitability of the owners, any new directors, and senior managers, as well as the soundness of any new business plan.

2000 Assessment: This principle was found to be not observed.

2004 Observation: Requirements concerning the transfer of blocks of shares of companies that would amount to a transfer of control are the same as those required for initial licensing of companies. Rules should be set by the supervisor, but enforcement would require the backing of legislation. There should be a formal notice of the intent to make such a transfer along with written criteria, which should be used to make the assessment of the appropriateness of the change. Such an authority is not currently provided by Kazakhstani legislation.

Currently, in order to acquire the right to control, possess, use, and dispose of more than 25 percent of the voting shares in an insurance or reinsurance organization, a shareholder must obtain the permission of the FSA. The procedures are determined by regulation issued by the FSA. Financial instability of the shareholder is ground for denial of a permission to acquire the right of control over an insurance or reinsurance organization. The FSA may require submission of founding documents, financial reports from founders, shareholders, and other legal entities having the control over an insurance or reinsurance organization. The FSA can also request necessary information from state agencies to the extent of their competence on matters related to the financial stability of such entities.

A person intending to acquire ownership or management of voting shares in an insurance or reinsurance organization of more than five percent of the total number of voting shares must notify FSA within 10 days after having purchased the shares. However, the rules on “changes in control” are still incomplete.

Principle 4: Corporate governance

It is desirable that standards be established in the jurisdictions that deal with corporate governance. Where the insurance supervisor has responsibility for setting requirements for corporate governance, the supervisor should set requirements with respect to:

• the roles and responsibilities of the board of directors;

• reliance on other supervisors for companies licensed in another jurisdiction; and

• the distinction between the standards to be met by companies incorporated in its jurisdiction, and branch operations of companies incorporated in another jurisdiction.

2000 Assessment: This principle was found to be not observed. At the time of 2000 FSAP, standards for corporate governance were not established.

2004 Observation: Legislative arrangements and standards for the requirements that govern the role and responsibilities of the board of directors of insurance companies, the system for internal control of the management as well as for internal audits have now been introduced.

In addition to the matters regarding competence of the board of directors, the legislation also require that the board of directors of an insurance or reinsurance organization shall be competent and able to consider matters related to violations of legislative requirements with regard to the financial stability and solvency of insurance and reinsurance organizations, based on the opinion of an authorized auditor, internal audit, or actuary.

An insurance or reinsurance transaction shall be deemed major, if the insured sum exceeds 25 percent of assets of the insurance company. Decisions to enter into major transactions must be approved by the board of directors of the insurance or reinsurance organization based on a preliminary opinion of an actuary.

Principle 5: Internal controls

The insurance supervisor should be able to:

• review the internal controls that the board of directors and management approve and apply, as well as to require strengthening of these controls where necessary; and

• require the board of directors to provide suitable prudential oversight, such as setting standards for underwriting risks and setting qualitative and quantitative standards for investments as well as liquidity management.

2000 Assessment: This principle was found to be not observed. Standards with regard to internal controls that the board and its management must apply, and to require strengthening where necessary, and the standards set by the board for underwriting risks and for setting qualitative and quantitative standards for investment and liquidity management did not exist.

2004 Observation: Improvements have been made in the legislation to regulate the internal audit requirements. However, there does not appear to be sufficient requirements for investment and liquidity management. There is a special regulation under preparation concerning conducting of internal audit procedures.

Principle 6: Prudential rules

The situation has not changed much since the 2000 FSAP. Consistent with the IAIS principles, the authorities maintain prudential standards designed to limit or manage the amount of risk that a company will undertake on a single exposure. All risk with a liability exceeding 10 percent of an insurer’s assets must be reinsured. For small companies seeking to do business with clients that have very large exposures, such as petroleum companies in Kazakhstan, the consequence of the rule is that substantial elements of these policies must be reinsured with other companies, most of it with large international reinsurers not resident in Kazakhstan. This is an appropriate way to address risks involved in large exposures. The insurance rules also impose a condition that companies must retain at least five percent of the risk on any single policy for its own account. This rule is appropriate, as it seeks to ensure that insurance companies are legitimately engaged in assuming insurance liabilities and are not merely acting as brokers for their clients.

Prudential rules: assets

Standards should be established with respect to the assets of companies licensed to operate in the jurisdiction. Where insurance supervisors have the authority to establish the standards, these should apply at least to an amount of assets equal to the total of the technical provisions, and should address the following: diversification by type; any limits or restrictions on the amount that may be held in financial instruments, property, and receivables; the basis for valuing assets, which are included in the financial reports; the safekeeping of assets; appropriate matching of assets and liabilities; and liquidity.

2000 Assessment: This principle was found to be partially observed. At the time of the FSAP, boards were not required to have investment policies, “per parcel” limits that would restrict the maximum exposure to any single counterparty, rules regarding the safekeeping of assets, or requirements that would deal with the appropriate matching of assets and liabilities.

2004 Observation: Currently, there is a special regulation that deals with the appropriate matching of assets and liabilities for the investment policy of insurance companies.

Principle 7: Liabilities

Insurance supervisors should establish standards with respect to the liabilities of companies licensed to operate in their jurisdiction. In developing the standards, the insurance supervisor should consider the following:

• what is to be included as a liability of the company, for example, claims incurred but not paid, claims incurred but not reported, amounts owed to others, amounts owed that are in dispute, premiums received in advance, as well as the provision for policy liabilities or technical provisions that may be set by an actuary;

• the standards for establishing policy liabilities or technical provisions; and

• the amount of credit allowed to reduce liabilities for amounts recoverable under reinsurance arrangements with a given reinsurer, making provision for the ultimate collectability.

2000 Assessment: This principle was found to be partially observed. In 2000, there was uncertainty regarding the establishment of provisions for “unexpired risks”, technical reserves, and mathematical provisions.

2004 Observation: While provisions for unexpired risks still are uncertain, the other provisions have been established. To fulfill the commitments undertaken under current insurance and reinsurance contracts, an insurance or reinsurance organization must generate insurance reserves to the amount that is calculated by a licensed actuary.

The FSA has set additional rules to estimate insurance liabilities. For the non-life insurance business, they also include provisions for: unearned premium, claims incurred but not paid, and claims incurred but not reported. For the life insurance business, these include mathematical provisions and loss reserves. These are all required to be calculated mathematically according to actuarial principles and standards.

There are still no special rules or directives on how to calculate the provision for unexpired risks. Insurance companies, however, are obligated to set aside additional reserves in accordance to the actuarial report that is mandated to be produced twice a year.

The insurance reserves can be reduced by the amount of the reinsurer’s recoverable, provided the reinsurer has a special credit rating from one of the assigned rating agencies. The share of the reinsurer’s recoverable in insurance reserves is also required to be calculated mathematically following actuarial standards and practice.

Principle 8: Capital adequacy and solvency

The requirements regarding the capital to be maintained by companies which are licensed or seek a license in the jurisdiction, should be clearly defined and should address the minimum levels of capital or the levels of deposits that should be maintained. Capital adequacy requirements should reflect the size, complexity, and business risks of the company in the jurisdiction.

2000 Assessment: This principle was found to be fully observed.

2004 Observation: Efforts have been made by the authorities to introduce EU standards in national legislation. The capital requirements in the new law are based on the approach of the EU directives on solvency. Minimum capital depends on the value of the business or classes of insurance. For newly established companies the minimum capital is as follows:

^1/Additional requirements for the classes vary from T 5–20 million for each class. There are 4 classes in life insurance and 16 classes in non-life insurance.

Non-life insurance companies	T 130 million + classes 1/
Life insurance companies	T 150 million + classes 1/
Reinsurance companies	T 230 million

^1/Additional requirements for the classes vary from T 5–20 million for each class. There are 4 classes in life insurance and 16 classes in non-life insurance.

View Table

Non-life insurance companies	T 130 million + classes 1/
Life insurance companies	T 150 million + classes 1/
Reinsurance companies	T 230 million

^1/Additional requirements for the classes vary from T 5–20 million for each class. There are 4 classes in life insurance and 16 classes in non-life insurance.

Active insurance companies have the following capital requirements. For non-life insurance companies, there are three types of calculations affecting the minimum capital requirement:

• 1) T 100 million + classes;

• 2) T 100 million + 16 percent of insurance premiums for the last financial year multiplied on the ratio;

• 3) T 100 million + 23 percent of burden of claims for the last financial year multiplied on the ratio.

• The ratio is, based on the last financial year, the difference between the amount of claims remaining to be borne after deduction of transfers for reinsurance and the gross amount of claims, which may in no case be less than 0.5.

For life insurance companies, there are two types of calculations, and the highest result stipulates the minimum capital requirement:

• 1) T 130 million + classes;

• 2) T 130 million + 4 percent of insurance reserves.

Principle 9: Derivates and off-balance sheet items

This section applies in jurisdictions, where derivatives or other items are not reported on the balance sheet and thus are not subject to the reporting requirements established for financial statements.

The insurance supervisor should be able to set requirements with respect to the use of financial instruments that may not form a part of the financial report of a company licensed in the jurisdiction. In setting these requirements, the insurance supervisor should address:

• restrictions in the use of derivatives and other off-balance sheet items;

• disclosure requirements for derivatives and other off-balance sheet items; and

• the establishment of adequate internal controls and monitoring of derivative positions.

• 2000 Assessment: This principle was found not to be applicable at the time.

2004 Observation: The new legislation has made this principle relevant. According to current legislation, the financial reports should contain information on derivatives and off-balance sheet items (i.e., SWAPs, forwards, futures), information on guarantees, conditional liabilities, the property including machinery that giving rent, debts that are accounted as loss, etc., in accordance with international standards.

Principle 10: Reinsurance

This section applies in jurisdictions, where reinsurance companies are not subject to the same supervisory rules as insurance companies. Insurance companies use reinsurance as a means of risk containment. The supervisor must be able to review reinsurance arrangements, to assess the degree of reliance placed on these arrangements, and to determine the appropriateness of such reliance. Insurance companies would be expected to assess the financial positions of their reinsurers in determining an appropriate level of exposure to them.

The insurance supervisor should set requirements with respect to reinsurance contracts or reinsurance companies which address:

• the amount of the credit taken for reinsurance ceded. The amount of credit taken should reflect an assessment of the ultimate collectability of the reinsurance recoverables and may take into account the supervisory control over the reinsurer; and

• the amount of reliance placed on the insurance supervisor of the reinsurance business of a company.

2000 Assessment: This principle was not assessed due to lack of information. The supervisor needs to be able to review reinsurance arrangements, to assess the degree of reliance placed on these arrangements, to assess the degree of reliance placed on these arrangements and to determine the appropriateness of such reliance. The 2000 FSAP team was told that companies provide information to the supervisor on their reinsurance arrangements. However, the frequency of this reporting and the manner in which this information is collected and processed by the supervisor was not clear at the time of FSAP.

2004 Observation: According to current legislation, an insurance or reinsurance organization in Kazakhstan can transfer the insurance risks it has undertaken for reinsurance outside Kazakhstan with a reinsurance organization that is not a Kazakhstan resident, directly, through a resident insurance broker, or nonresident broker, provided that these reinsurance organizations and insurance brokers have a specified rating. The list of rating agencies and the minimum rating is currently being prepared by the FSA.

At present, there is a special regulation regarding Kazakhstani insurance brokers’ activity, including requirements for the reinsurance cover and responsibility of the brokers.

Principle 11: Market conduct

Supervisors must ensure that insurers and intermediaries exercise the necessary knowledge, skills, and integrity in dealings with their customers. Insurers, intermediaries, and customers must disclose relevant information to each other with a view to ensure fair contractual and other treatment; conflicts of interest must be avoided. In particular, supervisors:

• require insurers and intermediaries to have clearly stated policies in place on how to treat customers fairly;

• must regularly monitor compliance with the stated market conduct policies of insurers and intermediaries;

• must set policy and guidelines with regard to compulsory disclosure to the customer of relevant, meaningful, and understandable information regarding the insurer, intermediary, product, risks, benefits, obligations, charges, and estimated returns;

• require insurers and intermediaries to seek information from their customers, which might reasonably be expected, before giving advice or concluding a contract;

• require insurers and intermediaries to have internal rules in place to avoid conflicts of interest, and how to ensure fair treatment of customers if conflicts arise; and

• require insurers and intermediaries to deal with customer complaints effectively and fairly through a simple and equitable process. This process should be well disclosed and easily accessible.

2000 Assessment: This principle was found to be partially observed. Market conduct supervision in Kazakhstan was limited to monitoring the application of tariffs for motor vehicle insurance and publication of rules concerning other forms of mandatory insurance.

2004 Observation: Insurance companies are required to submit for approval by the FSA, rules concerning conditions for each type of insurance they conduct. The insurance company should carry out its activity in strict accordance with the approved rules. The rules should also contain information on tariffs and calculation of the tariffs. There is a special FSA division dealing with complaints of customers. If the customer feels that the insurance company violates the legislation or other regulations, the customer can send a written complaint about the insurance company, insurance broker, and the like to the FSA. The FSA is required to follow up on all such complaints.

Principle 12: Financial reporting

It is important that insurance supervisors get the information they need to properly form an opinion on the financial strength of the operations of each insurance company in their jurisdiction. The information needed to carry out this review and analysis is obtained from the financial and statistical reports that are filed on a regular basis. A process should be established for:

• setting the scope and frequency of reports requested and received from all companies licensed in the jurisdiction, including financial reports, statistical reports, actuarial reports, and other relevant information;

• setting the accounting requirements for the preparation of financial reports in the jurisdiction;

• ensuring that external audits of insurance companies operating in the jurisdiction are acceptable; and

• setting the standards for the establishment of technical provisions or policy and other liabilities to be included in the financial reports in the jurisdiction.

In doing so, a distinction may be made:

• between the standards that apply to reports and calculations prepared for disclosure to policyholders and investors, and those prepared for the insurance supervisor; and

• between the financial reports and calculations prepared for companies incorporated in the jurisdiction, and branch operations of companies incorporated in other jurisdictions.

2000 Assessment: This principle was found to be broadly observed. At the time, a project was under way to develop new accounting standards for insurance companies. The resulting standards were to be prescribed for use in all financial statements prepared in respect of the business of supervised insurance companies. Furthermore, the accounting and auditing profession in the country were not familiar with insurance business and its special accounting characteristics.

2004 Observation: Currently, two regulations address the financial reporting of insurance and reinsurance companies as wells as insurance brokers:

• one includes instructions regarding forms and terms of financial reporting of insurance and reinsurance companies as well as insurance brokers. This regulation was passed in order to further the development of accounting practice and provides transmission of international standards on financial reporting. The document was developed in accordance with international accounting practices.

• another deals with specifications for the accounting of assets, liabilities, equity, income, expenses, and similar issues for insurance and reinsurance companies in accordance with international practice of insurance accounting.

A financial report observing this regulation is required to be submitted on a monthly and quarterly basis to the FSA. The regulations also cover the procedures, forms, and terms of annual financial reports of insurance and reinsurance companies. They specify how annual reporting and external audit procedures of annual financial report should be carried out.

Principle 13: Onsite inspection and access to information

• The insurance supervisor should be able to:

• carry out on-site inspections to review the business and affairs of the company, including the inspection of books, records, accounts, and other documents. This may be limited to the operation of the company in the jurisdiction or, subject to the agreement of the respective supervisors, include other jurisdictions in which the company operates; and

• request and receive any information from companies licensed in its jurisdiction, whether this information is specific to a company or requested of all companies.

2000 Assessment: This principle was found to be broadly observed. On-site inspection was a relatively new activity at the time of the 2000 FSAP.

2004 Observation: The FSA has established internal rules and directives in order to carry out on-site inspections. They describe in detail the subject of inspections and focus on areas of highest risk to the insurance company, such as solvency, capital adequacy, insurance reserves, and unexpired risks. Inspectors have the right to request from the insurance company any additional internal documents, such as books, records, all accounts, etc. during an inspection. These rights give inspectors the opportunity to see the entire picture, including the solvency of the insurance company. Both on-site and off-site reports are used in the analysis of the company.

Principle 14: Sanctions

Insurance supervisors must have the power to take remedial action where problems involving licensed companies are identified. The supervisor must have a range of actions available in order to apply appropriate sanctions to problems encountered. The legislation should set out the powers available to the supervisor and may include:

• the power to restrict the business activities of a company, for example, by withholding approval for new activities or acquisitions;

• the power to direct a company to stop practices that are unsafe or unsound, or to take action to remedy an unsafe or unsound business practice; and

• the option to invoke other sanctions on a company or its business operation in the jurisdiction, for example, by revoking the license of a company or imposing remedial measures where a company violates the insurance laws of the jurisdiction.

2000 Assessment: This principle was found to be broadly observed. The legislation in effect in 2000 provided sufficient powers to the supervisor to impose sanctions on companies that failed to meet the requirements.

2004 Observation: The new legislation has been further developed, and it provides for enhanced and adequate powers, which enable the FSA to apply a broad range of sanctions to solve the problems as soon as detected.

Principle 15: Cross-border business

Insurance supervisors should apply the following principles to the supervision of cross-border business operations:

• no foreign insurance establishments should escape supervision;

• all insurance establishments of international insurance groups and international insurers should be subject to effective supervision;

• the creation of a cross-border insurance establishment should be subject to consultation between host and home supervisors; and

• foreign insurers providing insurance cover on a cross-border services basis should be subject to effective supervision.

2000 Assessment: This principle was found not to be applicable.

2004 Observation: According to current legislation, insurance companies with foreign capital participation—partial or full—are also subject to regulation and supervision. In order to establish an insurance business in Kazakhstan, foreign insurers must establish an insurance company in Kazakhstan or buy an existing insurance company. International insurance groups and international insurers planning to create an insurance company in Kazakhstan must get an approval from their local supervision agency and provide a copy to the FSA.

Principle 16: Coordination and cooperation

In order to share relevant information with other insurance supervisors, adequate and effective communications should be developed and maintained. In developing or implementing a regulatory framework, consideration should be given to whether the insurance supervisor:

• is able to enter into an agreement or understanding with any other supervisor both in other jurisdictions and in other sectors of the industry (i.e., insurance, banking or securities) to share information or otherwise work together;

• is permitted to share information, or otherwise work together, with an insurance supervisor in another jurisdiction. This may be limited to insurance supervisors, who have agreed, and are legally able, to treat the information as confidential;

• should be informed of findings of investigations where power to investigate fraud, money laundering, and other such activities rests with a body other than the insurance supervisor; and

• is permitted to set out the types of information, as well as the basis on which information obtained by the supervisor may be shared.

2000 Assessment: This principle was not assessed due to lack of information.

2004 Observation: There was no opportunity to assess the extent to which the insurance supervisors in Kazakhstan liaise with supervisors in other jurisdictions. The FSA, and previously the NBK, has been a member of IAIS since 2000. On-site inspectors and other specialists according to their responsibilities and current jobs cooperate with supervisory authorities of other countries, which also are members of IAIS through letters and requests. Legislation regarding money laundering and combating financing of terrorism is currently being prepared.

Principle 17: Confidentiality

All insurance supervisors should be subject to professional secrecy constraints in respect of information obtained in the course of their activities, including during the conduct of on-site inspections. The insurance supervisor is required to hold confidential any information received from other supervisors, except where constrained by law or in situations where the supervisor, who provided the information, provides authorization for its release.

Jurisdictions whose confidentiality requirements continue to constrain or prevent the sharing of information for supervisory purposes with insurance supervisors in other jurisdictions, and jurisdictions where information received from another supervisor cannot be kept confidential, are urged to review their requirement.

2000 Assessment: This principle was found to be fully observed.

2004 Observation: FSA employees are required to keep confidential any information they receive in the course of their activities, including on-site inspections. There are a few common laws on confidentiality of civil servants that should be maintained by the staff of the FSA. A special chapter in the Civil Code on “insurance secrecy” also determines the responsibility of FSA staff concerning unauthorized disclosure of information. Financial and other reports of insurance companies that submitted electronically to the FSA are encoded.

Update on transparency in monetary policy

42. The 2000 FSAP report on monetary and financial transparency concluded that the National Bank of Kazakhstan (NBK) was relatively transparent in its conduct of monetary policies. At the same time, the report emphasized that some areas required improvements, particularly with respect to central banks governance and internal audit. Specifically, the assessors concluded that the law on central bank should list general criteria for the removal of the heads and members of the governing body of the central bank. Also, the information on the structure and functions of the central bank’s policy making body was not available to the public. The assessors stressed that disclosed financial statements lacked information on auditing policies and did not provide the public with qualifications. In addition, the documents on internal auditing and practices of internal audit division were not publicly disclosed.

Update of transparency in financial policies

46. The 2000 FSAP report on transparency in financial policies concluded that the NBK had significantly improved its transparency practices. It was mentioned that the NBK used essentially identical vehicles for achieving transparency both in monetary and financial policies. There were only few areas where disclosure standards were not fully observed. In addition, some coordination problems between two financial supervision agencies were noted.

Information and methodology used for the assessment

53. A detailed assessment of Kazakhstan’s compliance with the international standards on anti-money laundering (AML) and combating the financing of terrorism (CFT) was prepared by a team of assessors that included staff of the International Monetary Fund (IMF), the World Bank (WB), and an independent law enforcement expert.¹⁴ As stipulated by the methodology, the latter was not under the supervision of IMF and WB staff, but he was selected from a roster of experts on criminal law enforcement and on non-prudentially regulated activities. IMF and WB staff reviewed the relevant AML/CFT laws and regulations, and supervisory and regulatory systems in place to deter money laundering (ML) and financing of terrorism (FT) among regulated financial institutions. The law enforcement expert, who is not under the supervision of IMF and WB staff, reviewed the capacity and implementation of criminal law enforcement systems. The law enforcement expert’s assessment and comments are in italics.

54. The assessment team experienced good collaboration. The team met with representatives of the following agencies: the Ministry of Justice, the General Prosecutor’s Office, the Ministry of Finance, the Agency for the Fight Against Economic and Corruption Crimes, the Ministry of Interior, the Kazakhstan’s National Security Committee (KNB), the Customs Department, the Regulation and Supervision Agency of the Financial Market and Financial Institutions (FSA), the National Bank of Kazakhstan (NBK), the Association of Financiers, and the Central Securities Depository (CSD). In addition, the team met in Almaty with representatives of commercial banks, local securities broker/dealer, and external auditors.

General situation of money laundering and financing of terrorism

55. Reputational risk remains a potential concern for financial sector stability and the authorities’ development plans. For instance, some banks rely on foreign funding. Kazakhstan’s economic recent growth is largely based on substantial oil, gas and mineral reserves; and was facilitated by early reforms, such as its rapid privatization in the 1990s. Its geographic location, however, renders it a potentially convenient drug trafficking corridor.¹⁵ The authorities indicated that they have arrested persons for drug trafficking who may have been using the proceeds to fund terrorism. These factors, together with organized crime, regional security issues, lack of transparency linked to natural resource management, particularly the energy and mineral sector, and the need to encourage foreign investment create substantial challenges in respect of limiting risks related to money laundering and terrorist financing. Because the links between drug trafficking and terrorism in the region could present serious challenges to regional and economic stability, lack of attention to implementing appropriate AML/CFT policies, procedures and sanctions could handicap Kazakhstan’s development efforts.

Overview of measures to prevent money laundering and the financing of terrorism

56. Kazakhstan has signed international conventions that are directly relevant for AML/CFT legislation, with the exception of the Palermo and the Strasbourg Conventions. The Vienna Convention has been signed and ratified although it has not been fully implemented. The UN Security Counsel Resolutions relating to the financing of terrorism have not been not implemented by Kazakhstan, although the various lists have been forwarded by the government to the relevant competent authorities and also circulated to various ministries for review and investigation. The private sector is complying with the process on a voluntary basis. To date, no names have matched names on the UN lists.

57. The existing legislative framework recognizes ML and FT, but does not observe the international standards. The Criminal Code recognizes money laundering as a financial crime; however, its legal definition does not yet meet recognized international conventions and standards.¹⁶ A financial intelligence unit (FIU) does not exist. The provisions in the banking law on bank secrecy law subjects anyone to criminal sanctions who discloses suspicious transaction data even to authorized bodies. Only the Prosecutor’s Office has the authority to pierce the bank secrecy provisions when investigating a criminal matter. Financing of terrorism has been added to the definition of Terrorist Activity in the Law of the Republic of Kazakhstan of July 13, 1999 No. 416-1 on Combating Terrorism (with changes introduced by the Law of the Republic of Kazakhstan as of February 19, 2002 No 295-II). However, financing of terrorism has been not been criminalized as a separate offense from terrorism in the Criminal Code. Therefore, while terrorism is a predicate offense for money laundering, financing of terrorism is not. Although this will allow the authorities to pursue the financing of terrorism in some limited circumstances as part of terrorist activity, it does not fully satisfy the requirements on combating financing of terrorism and international cooperation as set out in the International Convention on the Suppression of the Financing of Terrorism (ICSFT).

58. The authorities recognize the existing legal framework is insufficient in the current environment and have initiated measures. Kazakhstan remains a relatively cash-based economy, which impedes the ability of enforcement authorities to pursue investigations and convict criminals for organized crime, money laundering, and terrorist financing. Furthermore, controls on precious metals, including those of strategic significance, do not currently exist, although there are plans to regulate the metals market. Officials also recognize that there exists a significant unregulated economy in Kazakhstan, which thrives outside the formal financial sector, although that may be more related to tax evasion than ML and FT. Government officials from various enforcement and financial sector regulatory agencies have participated in AML/CFT training programs over the past year, which indicates emerging political will to build a legal framework to combat money laundering and terrorist financing.

59. Kazakhstan has continued its efforts to improve and consolidate its financial sector supervisory capacity by the establishment of a newly created Agency on Regulation and Surveillance of Financial Markets and Organizations (FSA), which is responsible for regulating and licensing of banks, insurance companies, capital markets, and other financial sector entities. As the FSA started its operations January 1, 2004, it has yet to fully establish its surveillance and supervisory activities, though admittedly it is carrying on the tasks that were previously with the NBK.

60. The drafting of a new comprehensive AML/CFT law, which will meet international standards, has begun and been tasked to the Agency for the Fight Against Economic and Corruption Crimes.¹⁷ Other legislation will have to be amended accordingly, including: the Criminal Code, the Criminal Procedure Code, Banking Law, Insurance Laws, Securities Laws, and laws governing other commercial entities, Financial Sector Supervisory legislation, the Law on the Prosecutor’s Office (1995), provisions relating to mutual legal assistance and cooperation in the Criminal Procedures Act. Due to the lack of a comprehensive AML/CFT law, the legal tools and mechanisms for officials to prevent and deter money laundering and terrorist financing activities are limited.

Assessing criminal justice measures and international cooperation

Description of the controls and monitoring of cash and cross border transactions