Background

On 5 May 2017, the Securities and Futures Commission (the “SFC”) issued a Consultation Paper (the “Consultation Paper”) on the Proposed Guidelines on Online Distribution and Advisory Platforms (the “Guidelines”). For a summary of the Consultation Paper, please refer to our newsletter:When You Have a Non-Human Investment Advisor….

The consultation ended on 4 August 2017. On 28 March 2018, the SFC issued their consultation conclusions (the “Consultation Conclusions”) on the Guidelines, and a further consultation on adopting the additional measures applicable to online sales of complex products (eg, ensuring suitability of the products) to offline sales of such products (the “Further Consultation”).

Application of the Guidelines

The Guidelines apply to all SFC-licensed and registered persons when conducting regulated activities in Hong Kong in providing order execution, distribution and advisory services in respect of investment products via online platforms (whether or not the platforms target Hong Kong investors) (“Platform Operators”). The SFC will take into account an intermediary’s activities targeting Hong Kong investors via all channels in their totality.

Platform Operators are equally required to comply with all applicable legal and regulatory requirements in carrying out their regulated activities. The type of licence required to operate an online platform depends on the regulated activity to be performed.

Core Principles for the Operation of Online Platforms

Disclosure requirements

Platform Operators have an obligation to make clear and adequate disclosure of relevant material information. For example, where risk ratings for investment products are provided by Platform Operators, they shall disclose the methodologies adopted for assessing and assigning the risk ratings to investment products and categorising clients to enable clients to form a general understanding of the methodology adopted for risk ratings provided by online platforms.

Platform Operators should exercise their professional judgment about the scope and frequency of reviews. The SFC expects that the regular review should be conducted at least annually.

Use of third-party data

Platform Operators shall act with due skill, care and diligence in the selection, appointment and ongoing monitoring of third-party service providers to enable the Platform Operator to be reasonably satisfied that the information provided by the service provider is accurate and reliable.

Materials concerning non-SFC-authorized Exchanged Traded Funds (“ETFs”)

Platform Operators should ensure that they comply with Part IV of the Securities and Futures Ordinance (Cap 571)(“SFO”) (restriction on offers of investments to the Hong Kong public). The key issue is whether information in the platform would amount to an advertisement, invitation or document that is or contains an invitation to the public to invest in those ETFs. They shall use methods which are appropriate to satisfy themselves that an investor is a professional investor. A client’s self-declared confirmation is not sufficient.

Robo-advice

In the Consultation Paper, the SFC had previously referred to robo-advice as including: (1) full automation; (2) adviser-assisted; and (3) guided advice. The SFC has clarified that the scope of robo-advice under the Guidelines only applies to the provision of investment advice using client-facing technology tools.

Information about the limitations of the robo-adviser’s services and how and when the algorithm might rebalance a client’s portfolio shall be provided to clients. Overly technical terms should be avoided.

Robo-advisers shall have in place internal controls to detect possible failures and halt trading when necessary. They should decide whether it would be in the best interest of clients to override the algorithm or even suspend trading activities.

A suitably-qualified person with the experience and competency is required to test and review the algorithm used to generate the investment advice as well as the reasonableness of the advice.

Suitability requirement

Triggering of the Suitability Requirement

Whether the Suitability Requirement is triggered would depend on whether the human interaction involves a solicitation or recommendation which requires an analysis of the content and context of each interactive communication. Some examples are provide by the SFC.

Discharging the Suitability Requirement

Whenever making a recommendation or solicitation, Platform Operators shall ensure the suitability of the recommendation or solicitation for that client is reasonable in all the circumstances. The Suitability Requirement can be properly discharged via an online platform through its proper design and operation.

Platform Operators should collect from each client information that includes the client’s investment knowledge, investment horizon, risk tolerance and capacity to make regular contributions and meet extra collateral requirements, where appropriate. They should consider the overall effect of their recommended product on their clients’ portfolios.

Regarding risk analysis and profiling, the SFC’s regulations are principles-based and Platform Operators should formulate their own risk analysis and assessment methodologies taking into account both qualitative and quantitative factors.

Sale of complex products on online platforms on an unsolicited basis

What is a complex product?

The key to determining what is a complex product is whether, objectively, it is likely that a retail investor is able to understand its terms, features and risks and it is difficult to be valued with a high degree of confidence. The assessment is not dependent on any particular client.

When considering whether a product is a complex one, the presence of any one of the factors likely suggests that the product should be considered a complex product, but each product should be holistically assessed on the basis of the totality of the facts depending on its particular terms and features. The SFC will provide further guidance by way of FAQs as well as a non-exhaustive list of investment products which are considered either non-complex or complex to facilitate understanding.

Suitability in the sale of complex products online

Intermediaries are currently responsible for ensuring suitability whenever they solicit or recommend a financial product to a client. In the future, they will also be responsible for ensuring suitability whenever a client transacts in complex products online (regardless of whether there has been any solicitation or recommendation), and also even in the case of repeat purchases.

Further consultation

The SFC proposes making amendments to the Code of Conduct to align the regulatory requirements for both online and offline sales and ensure a level playing field. The Further Consultation will close on 28 May 2018.

Conclusion

The Guidelines will become effective on 6 April 2019. Amongst other things, the SFC will adopt its controversial proposal to require that Platform Operators ensure the suitability of unsolicited online transactions in complex products (subject to certain limited carve-outs). This is a fundamental change to the concept of when (and why) suitability is triggered in Hong Kong. It will first apply in the online context and is proposed to be further extended to the offline context in due course.

In light of the above, Platform Operators are reminded to review all the products they provide on the platform, the online sales system, online-specific terms and conditions and other matters to ensure that they fully comply with the Guidelines.

For enquiries, please contact our Litigation & Dispute Resolution Department:

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Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.