HK regulator turns up heat on intermediaries

Changes announced yesterday by the Securities and Futures Commission herald stricter requirements for financial firms selling products and services to professional investors.
HK regulator turns up heat on intermediaries

Hong Kong’s securities regulator yesterday announced amendments to rules governing how professional investors are treated, which will have a significant effect on the intermediaries that service them.

Intermediaries, such as private banks and hedge fund managers, will no longer be exempt from many of the rules protecting individual investors when they are dealing with professional investors.

In addition, individual professional investors (IPIs) and corporate professional investors (CPIs) will continue to be allowed to invest in private placements. The minimum monetary threshold to qualify as IPIs or CPIs will remain at current levels.

And a principles-based tests will replace the specific tests now used to assess whether exemptions apply when intermediaries serve professional investors.

The Securities and Futures Commission (SFC) will also consult further on client agreement requirements – specifically on the wording of a ‘suitability requirement’ clause it proposes incorporating in all such agreements. This is despite most respondents being against this proposal, many citing increased compliance costs.

The changes follow a three-month consultation process that ended on August 14, 2013.

Intermediaries serving individual and corporate professional investors are currently exempt from, among other rules, establishing the client’s financial situation and knowledge of derivatives and providing a risk-disclosure statement.

The SFC had argued that as most sales misconduct cases in Hong Kong involved individual investors, IPIs merited greater protection than CPIs.

It had therefore proposed to remove the exemptions entirely so that intermediaries would need to comply with all requirements when dealing with any individual investor.

But following the consultation process, the regulator has drawn a distinction between rules that are fundamental for investor protection, and those that are not and therefore can be waived.

Notably, intermediaries serving IPIs will no longer be exempt from the SFC’s suitability requirement. This obliges intermediaries to ensure the suitability of their solicitations and recommendations is reasonable in all circumstances.

The regulator has proposed incorporating the clause into client agreements as a contractual term and to ban contractual terms that are inconsistent with the requirement.

Following requests to clarify the terms of the requirement, the SFC will conduct a study after which it will publish further guidance. This consultation will end on December 24.

Moreover, for discretionary accounts, intermediaries will now need to obtain written authority from clients before conducting transactions on their behalf, and must confirm the agreement annually.

The SFC had also sought views on whether IPIs should be allowed to continue to invest in private placements, or whether the HK$8 million ($1 million) threshold for IPI and CPI should be increased.

Most respondents supported the status quo, and the regulator will continue to allow IPIs and CPIs to invest in private placements and will maintain the current threshold.

To read the SFC’s consultation conclusions in full, click here.

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