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Enhanced Disclosure Requirements for Sale of Investment Products have come into effect

2018-10-01

The Securities and Futures Commission (“SFC”) published its Consultation Conclusions on Proposals to Enhance Asset Management Regulation and Point-of-sale Transparency and Further Consultation on Proposed Disclosure Requirements Applicable to Discretionary Accounts in November 2017, which adopted important new rules to enhance Hong Kong’s asset management regulations.

In addition to making extensive changes to the Fund Manager Code of Conduct applicable to fund managers, the SFC also adopted important amendments on disclosure requirements in the Code of Conduct[1] to improve point-of-sale transparency and address potential conflicts of interest in the sale of investment products.

The changes, which are applicable to all intermediaries in their sale of SFC-regulated investment products, encompass enhanced disclosure requirements on arrangements involving receipt of monetary benefits which are not quantifiable at the point of sale and restrictions on use of the term “independent” and other terms with similar effects in all dealings with and communications to clients. Such disclosures are transaction specific and must be made to the client prior to or at the point of entering into a transaction.

The amendments have come into effect on 17 August 2018. The SFC has also published FAQs to provide practical guidance and set out its expectations on the minimum level of compliance. The FAQs will be updated from time to time.

For non-SFC-regulated products (such as structured products, including but not limited to currency linked or interest rate linked products), the Hong Kong Monetary Authority has also issued a circular to Authorised Institutions (“AIs”) requiring AIs to comply with the same enhanced disclosure and independence requirements set out in the Code of Conduct when distributing such non-SFC-regulated products. AIs are expected to implement these enhanced requirements before the end of 2018.

Separately, the SFC released consultation conclusions on proposed disclosure requirements for intermediaries providing discretionary account management services in May this year. The SFC will implement amendments to the Code of Conduct which will require intermediaries to disclose benefits receivable from product issuers as well as trading profits they make from products purchased from or sold to third parties when providing discretionary account management services to clients. The requirements address potential conflicts of interest arising from incentives provided by product issuers. The amendments will come into effect in late November 2018. The SFC has published FAQs (which will be updated from time to time) to provide further guidance to the industry.

Key Requirements

Assessing “independence” or “non-independence” status

The new rules require intermediaries to assess their independence status and restrict the situation in which intermediaries may represent themselves as “independent” or providing “independent advice”. “Independent” is broadly defined, which includes terms with similar meaning, such as “independent financial advisers” or “IFA”, “independent financial planners”, “impartial”, “neutral”, “objective” and “unbiased”. The assessment of independence is principles-based and depends on the facts and circumstances of each case.

In order to declare itself as “independent”, an intermediary must not:

  • receive fees, commissions, or any monetary benefits paid or provided (whether directly or indirectly) by any party in relation to the distribution of investment products to clients; and
  • have close links or other legal or economic relationships with product issuers, or receive any non-monetary benefits from any party, which are likely to impair its independence to favour a particular investment product, a class of investment products or a product issuer.

The SFC has provided examples of the meaning of “close links” which may impair independence of the intermediary, which include:

  • the intermediary has a parent company and subsidiary relationship with a product issuer, or is in a controlling entity relationship (as defined in the SFO) with the product issuer.
  • the intermediary and product provider have an exclusivity arrangement whereby the intermediary may only distribute that product provider’s investment products.

Disclosure of “independence” or “non-independence” status

Disclosure must be made whether an intermediary is independent or not, and such disclosure must also include the bases or rationale for determination. The SFC expects an intermediary to make, at a minimum, a one-off disclosure prior to or at the point of sale, as well as ongoing updates when there are any changes to the disclosed information.

The SFC also expects an intermediary to give due consideration of whether it is truly independent in all its dealings with the clients before making a one-off disclosure on independence, as specific disclosure of non-independence should only be required on very limited occasions.

If independence cannot be established, an intermediary will be restricted from describing itself as being independent (or words with similar effect) in any of its dealings with or communications to clients.

The amended Code of Conduct contains a form of disclosure statement relating to the status of independence that an intermediary is expected to communicate to its clients in its client documentation. This is set out in the new Schedule 9 of the Code of Conduct.

Disclosure of non-quantifiable monetary benefits

Where monetary benefits received or receivable from a product issuer (directly or indirectly) for distributing an investment product are not quantifiable prior to or at the point of entering into a transaction, in addition to disclosing the existence and nature of the monetary benefits, an intermediary must also disclose the maximum percentage receivable per year. This disclosure is expected to be made on a transaction basis, and where an amount received or receivable is disclosed, such amount must be annualised, to facilitate easy comparison of fees for investors.

By way of illustration, if an intermediary will receive trailer fees for distribution of Fund A, the SFC has provided a sample disclosure for distribution of Fund A: “We will receive from [the product issuer’s name] up to 60% of Fund A’s annual management fees as ongoing commission every year throughout the term of your investment”.

Key Actions

All intermediaries (including registered institutions) should take actions to ensure necessary measures are in place to comply with the amendments, such as making changes to operations and amending client agreements and marketing materials for sale of SFC-regulated investment products, and where new arrangements are entered into with product issuers affecting monetary benefits received or receivable, re-assess if updates to the existing information are required. The SFC expects that where a one-off disclosure is made to the client prior to or at the point of entering into a transaction, an updated one-off disclosure or individual disclosure for each transaction should be made if any information deviates from the information disclosed.

Exemption

Exemption from compliance with the enhanced disclosure requirements may be available for intermediaries (subject to conditions) when dealing with corporate professional investors and institutional professional investors under paragraph 15 of the Code of Conduct.

Conclusion

The new rules supplement existing protections to investors under the Code of Conduct in relation to disclosure of monetary and non-monetary benefits and conflicts of interest which already require intermediaries to act in the best interests of clients and to disclose affiliations with product issuers. The amendments are now contained in paragraphs 8.3(b)(ii), 8.3A(a)(iii) and 8.3A(b), 10.2 and Schedule 9 to the Code of Conduct.


[1]     The Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (“Code of Conduct”), updated from time to time.


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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.

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