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SFC issued a circular on distributors providing additional returns and other services or arrangements with marketing SFC-authorised funds

2024-05-30

Introduction

The Securities and Futures Commission (“SFC”) recently observes that intermediaries who distribute SFC-authorised funds (“Distributors”) have been offering additional returns or other incentives that distract clients from proper consideration of the risks and features of the underlying funds.

In light of the above practice, the SFC issued a circular on 24 October 2023 to summarize the SFC’s observations and reminds intermediaries of the legal and regulatory requirements to be met as fund distributors, including the requirements relating to “structured product”, prohibition against offering gift in promoting specific investment product, lock-up period and dealing frequency.

SFC’s observation on recent practice

SFC observed that some Distributors promoted SFC-authorised funds (often via online platforms) and offered or imposed some additional or distinct features or restrictions such as  “guaranteed returns” or “lock-up periods” which go beyond the features of the product set out in the funds’ offering documents.

The promotion of these SFC-authorised funds and services is often conducted through aggressive and high-profile marketing campaigns directing to the public.

Guaranteed returns

Prohibition against unauthorised promotion of structured product

As mentioned above, in some cases the Distributors offered an additional feature of “guaranteed returns” in promoting SFC-authorised funds. The “guaranteed returns” in such cases would commonly comprise:

1.       The actual return of the relevant fund(s) invested by the investor (i.e. fund return); and

 

2.       A top-up return to make up the difference between the fund return and the guaranteed rate of return offered by the Distributor.

In the circular, the SFC reminds that these guaranteed return arrangements may constitute a “structured product” under the Securities and Futures Ordinance (Cap. 571) (“SFO”) if the return to investors is determined by reference to the change in value of any securities (including funds).

If the arrangement does constitute a “structured product”, any advertisement, invitation or document which is or contains an invitation to the Hong Kong public to enter into or offer to enter into such structured products would amount to an offence under section 103 of the SFO, unless the SFC has authorised the issue or an exemption applies.

For SFC-authorised funds without guaranteed features, they are required to highlight in their offering documents that they do not have these features and the investors may not be able to get back the principal of their investment. Hence, any guaranteed returns additionally provided by Distributors may create a misleading impression that these returns are provided by the underlying SFC-authorised funds.

Prohibition against offering gift in promoting specific investment product

Not all the guaranteed returns would necessarily constitute a “structured product” under the SFO. Still, the SFC reminds Distributors to pay regard to another related regulatory requirement, namely paragraph 3.11 of the Code of Conduct for Persons Licensed by or Registered with the SFC (“Code of Conduct”) since such guaranteed returns may be considered as a gift that should not be offered to investors.

Paragraph 3.11 of the Code of Conduct provides that in promoting a specific investment product to a client, a licensed or registered person should not offer any gift other than a discount of fees or charges.

SFC reiterates the purpose of the above requirement is to avoid the use of gifts to divert investors’ attention from the features and risks of a particular investment product. If gifts are offered in such a way that they are linked to a particular type of investment product, such as certain types of funds or funds offered by certain fund houses, then such gifts will be bound by this requirement as investors may be distracted from the unique features and risks of such particular funds.

In light of the concerns above, when offering or promoting funds, Distributors should not offer additional returns (beyond the part of the product features set out in the relevant offering documents) or other incentives to investors in breach of section 103 of the SFO or paragraph 3.11 of the Code of Conduct.

Lock-up period and dealing frequency

During distribution of SFC-authorised funds, some Distributors additionally imposed a lock-up period on their clients’ investments or lowered the funds’ dealing frequency. For instance, clients’ redemption was only allowed on a weekly or monthly basis even though the fund provided daily dealing arrangements.

According to General Principle 1 (Honesty and fairness) of the Code of Conduct, in conducting its business activities, Distributors should act with due skill, care and diligence, in the best interests of their clients and the integrity of the market. It is not proper for them to restrict a client’s right to redeem his or her investment in a fund pursuant to the dealing frequency specified in the fund’s offering documents as such restrictions would limit that client’s ability to make timely and effective investment decisions in response to the changing market conditions or individual circumstances.

SFC appreciates that Distributors may have different fund dealing procedures or cut-off times for administrative efficiency. Still, SFC expects the Distributors to use their best endeavour to adhere to a fund’s dealing frequency as stipulated in its offering documents when dealing in the funds for clients, and not to reduce the fund’s dealing frequency.

Other marketing issues

In some cases without any offer of guaranteed rates of return, the Distributors highlighted prominently the regular interest payment or distribution features of the services which would in fact be derived from the actual return(s) of the underlying funds. SFC reminds intermediaries to ensure that they do not contain any misleading or deceptive information in preparing invitations and advertisements to promote their services and they must comply with paragraph 2.3 of the Code of Conduct.

Where Distributors highlight in an advertisement the financial returns derived from the underlying SFC-authorised fund(s), the advertisement should be prepared in a manner that is consistent with the principles under the SFC’s Advertising Guidelines Applicable to Collective Investment Schemes Authorized under the Product Codes. Specifically, the advertisement should avoid giving a misleading impression that the relevant services or the underlying funds would generate positive or guaranteed returns without any risk of loss, drawing a parallel between the services and the placement of cash on deposits or suggesting that the services are equivalent to bank deposits or savings.

Conclusion

The circular highlight the regulatory requirement that an intermediaries should note when promoting SFC-authorised funds. Specifically, intermediaries who have been offering additional returns or other incentives should note the above requirement to avoid contravening any legal or regulatory requirement. When in doubt, you are always advised to consult a funds lawyer.

 


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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.

Published by ONC Lawyers © 2023

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