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Hong Kong moves to improve investor protection
15/10/2014

Hong Kong : Changes to SFC Code of Conduct

The Hong Kong Securities and Futures Commission (SFC) has announced amendments to the Code of Conduct for Persons Licensed or Regulated with the SFC (the Code of Conduct) that will take effect in March 2016.

The changes will affect intermediaries when dealing with individual professional investors and corporate professional investors. Further amendments are expected to the Code of Conduct following the conclusion of an additional consultation period on the requirements of client agreements.

In the Code of Conduct professional investor regime, three classes of professional investors are covered – (a) institutional (b) corporate and (c) individual. The provisions relating to institutional professional investors are unchanged; such investors remain automatically exempted from the requirements of the Suitability Requirement under the Code of Conduct. However, the regulations applicable to corporate professional investors and individual professional investors have been amended. The changes can be summarised as follows.

At present, intermediaries are required to ensure that their solicitations and recommendations of financial products to their clients meet the ‘Suitability Requirement’ under the Code of Conduct, subject to an exemption when dealing with professional investors. However, this will change. With effect from March 2016 corporate and individual professional investors will be brought within the scope of the Code of Conduct and the current exemption, which excludes them from the protection of the Suitability Requirement, will be removed. This cover will extend to corporate professional investors that are the investment vehicles of individuals or family trusts.

Intermediaries will be required to conduct a ‘principles based’ assessment to determine whether the professional investor has sufficient experience and knowledge in the financial products being offered. In cases where the professional investor satisfies the requirements the intermediary will be exempt from the requirements of the Code of Conduct.

The principles based assessment is a three stage test to be applied by the intermediary to the corporate professional investor. The following questions must be asked:

• Does the corporate professional investor have an appropriate corporate structure, investment process and controls?

• Do those individuals in the organisation taking the investment decisions have sufficient investment background and investment expertise? and

• Is the risk in making the investment understood?

These changes will also benefit individual investors, whenever an intermediary acts on their behalf, regardless of whether they are a ‘professional investor’. In such a case, the ‘Suitability Requirement’ of the Code of Conduct will apply, plus all other requirements of the Code which are ‘inherently linked with the Suitability Requirement and/or have significant bearing on investor protection’ will also apply.

As stated the position of institutional professional investors remains unchanged; such investors remain automatically exempted from the Suitability Requirement.

FSC consultation on Client Agreements

The SFC is keen to establish greater investor protection and has also consulted on whether:

a) The Suitability Requirement in the Code of Conduct should be included as a standard contractual term in intermediary-client agreement;

b) The services to be provided by the intermediary should be set out in the client agreement; and

c) There should not be provision in client agreements that are inconsistent with the provisions of the Code of Conduct or misdescribe the services to be provided by the intermediary.

The SFC found that the majority of respondents were against these proposed changes. However, it has decided to push ahead with (a) above, as it is concerned that the present system can leave the client without redress against the intermediary when things go wrong. The SFC intends to establish the client’s contractual right to directly pursue the intermediary for compensation in the event of a breach. This remedy would be in addition to any regulatory action taken by the SFC following a breach of the Code of Conduct.

The SFC has prepared a standard clause to be inserted into intermediary /client agreements and opened a consultation on the clause. In summary, the clause provides that intermediary acknowledges that the financial products he solicits and recommend to the client are ‘reasonably suitable’ for that client, having due consideration to that client’s financial position, his investment experience and investment objectives. The clause in addition prevents the intermediary from derogating from the provisions of the clause. 

The consultation period closes in December.

Despite resistance the SFC has decided to push ahead with (c). A requirement will be added to the Code of Conduct to ensure that client agreements should not include terms inconsistent with the Code or misdescribe the services to be provided. However, this will not be introduced until the consultation period on the proposed standard clause has concluded.

In the light of feedback received during the consultation the SFC has decided to proceed no further with the suggestion at (b) that there must be a clear description of the services provided to the client.