1. Mar-Apr 2013 33
Welive in a world of relentless changes. In the
current climate, a change that the banking
community must face and prepare for is tightened
regulations. After the global economic downturn in 2008
resulted in the collapse of a venerable investment bank,
Lehman Brothers Holdings Inc., there has been an
upswing in regulatory actions taken by regulators in a
number of jurisdictions.
Lehman Brothers filed for bankruptcy in the United
States on 15 September 2008. In Hong Kong, both
the Securities and Futures Commission (SFC) and the
Hong Kong Monetary Authority (HKMA) received
numerous complaints from investors concerning
the conduct and selling practices of licensed
corporations, banks and other financial institutions
and their staff.
To address the issues, the SFC and the HKMA
issued consultation papers and reports in late 2008
and provided recommendations to strengthen the
financial industry’s regulations, product approval
regime, disclosure requirements processes and
dispute resolution mechanisms.
Regulations
for Combating the
“Mis-selling” of
Investment Products
Financial REGULATIONS
2. 34 Financial REGULATIONS
From time to time, the regulators have imposed new
measures and requirements on authorized institutions
and licensed corporations in relation to the conduct and
selling practices on investment products, with a view
to combating and controlling the risks of “mis-selling”
within the financial industry.
Code of Conduct under the SFC
The Code of Conduct for Persons Licensed by
or Registered with the Securities and Futures
Commission (hereafter called the “Code of Conduct”)
has been revised over the years to introduce new
measures and regulatory requirements. Some of the
key obligations relating to the selling and distributing of
investment products set out in the Code of Conduct in
June 2012 are as follows:-
• Investor characterization
Under paragraph 5.1A of the Code of Conduct,
except where a client is a professional investor,
intermediaries should – as part of the know-
your-client procedures – assess the client’s
knowledge of derivatives and characterize the
client based on their knowledge of derivatives.
It is important for intermediaries to explain
the relevant risks associated with investment
products to a client who is without knowledge of
derivatives. In addition, records of the warning
and other communications with the client should
be properly kept.
• Pre-sale disclosure of monetary
benefits
New disclosure requirements will ensure
intermediaries must deliver sales-related
information, including monetary and non-
monetary benefits received from the sale of an
investment product, to their clients prior to or at
the point of sale.
• Professional investors
If an investor who meets the definition under
Schedule 1, Part 1 of the Securities and Futures
Ordinance (Cap 571) and is assessed to be a
professional investor under the Securities and
Futures (Professional Investor) Rules and the
Code of Conduct, certain Code of Conduct
requirements can be waived, including
the need to ensure the suitability of a
recommendation or solicitation. However,
before intermediaries consider whether a
particular client is a professional investor, they
have to assess and be reasonably satisfied
that such a person is knowledgeable and has
sufficient expertise in relevant products and
markets, having regard to the following factors:
(a) the types of products traded;
(b) frequency and size of trades (to be
regarded as a professional investor, that
person would be expected to have traded
not less than 40 transactions per annum);
(c) dealing experience (a professional
investor would be expected to have been
active in the relevant market for at least
two years);
(d) knowledge and expertise in the relevant
products; and
(e) awareness of the risks involved in trading
in the relevant products and/or markets.
The assessment has to be in writing and documented.
Selling Practices Requirements for
Intermediaries
As one of the major developments in controlling “mis-
selling” practices, the SFC requires intermediaries
making investment recommendations or solicitations
be subjected to suitability obligations. Intermediaries
should take into consideration information about
their clients through the exercise of due diligence to
ensure the recommendation or solution for that client
is reasonable in all circumstances. Some of the key
suitability obligations include:
• Knowing your clients
Intermediaries need to know and understand
their clients, including their financial situation,
investment experience and investment
objectives. The client’s information needs to be
fully documented and updated on an ongoing
basis, where appropriate.
3. Mar-Apr 2013 35
Table One: Highlights of Requirements for Authorized Institutions (AIs) on Selling
Investment Products
Requirements Particulars
Disclosure of product information • AIs should make adequate disclosure of relevant material
information, including the name of the product issuer and the
issuer’s affiliation with the AIs (if any), to customers prior to or
at the point of sales.
• It is not sufficient to provide such information after a transaction
has been executed.
• Some special product features and risks of certain investment
products may warrant particular attention.
Product due diligence • AIs should ensure that, among other factors, the special
features and risks including the issuer’s credit risk, the hybrid
debt-equity nature, priority of claim, and the risks and price
volatility of the reference asset (especially for equity-linked
product linked to the worst performing stock) are properly taken
into account in their product due diligence process.
Pre-sale disclosure of benefits and
sales related information
• AIs are reminded to give adequate pre-sale disclosure to
customers of sales related information, including monetary and
non-monetary benefits received in selling investment products
regulated under the Securities and Futures Ordinance.
Concentration risks • AIs are reminded to make reference to paragraphs 5.2 and 5.3
of the Code of Conduct and the frequently asked questions
(FAQ) on Suitability Obligations issued by the SFC in May
2007.
• AIs may take into account relevant factors like product type
and nature, product risk ratings, customer’s investment
objectives and risk tolerance level, and so on, and consider
setting a lower threshold for higher-risk products, and using a
cumulative basis instead of per transaction basis in calculating
the concentration risk level.
Maintenance of order records • AIs are reminded to maintain proper records of client orders.
Use of mobile phones for receiving client order instructions
is discouraged. Where client order instructions are accepted
through mobile phones, the ti me of receipt and the order
details should be recorded immediately.
Source: Based on a Letter to The Chief Executives of all Authorized Institutions, Issued by
The HKMA on 5 January 2012.
4. 36 Financial REGULATIONS
• Product due diligence
Intermediaries need to understand the
investment products they recommend to clients.
Product due diligence should be conducted on a
continuous basis at appropriate intervals having
regard to the nature, features and risks of the
investment products being offered.
In addition, intermediaries should make their
own enquiries and obtain full explanations from
product issuers about the risks inherent in the
investment products. They should document
verification work and enquiries they have made
about the investment products, the criteria for
selecting the products and in what aspects
they are considered suitable for different risk
categories of investors, and the approval they
obtain from senior management for promoting
the products.
• Risk profiling
Intermediaries must match the risk return profile
of each investment product sold to a client to
the personal circumstances of that client. They
are required to exercise professional judgment
to assess whether the characteristics and risk
exposures of an investment product are suitable
for and in the best interests of the client.
• Providing all relevant material
information to clients to help
clients make informed decisions
Intermediaries are required to help their clients
make decisions by providing them with all the
relevant information about the recommended
investment products (such as prospectuses,
offering circulars, product key facts statements,
and so on) and proper explanations as to
why they are suitable for the clients. It is not
enough for the intermediaries to provide these
documents and ask the clients to read them
themselves, or merely read the documents to the
clients without explanations.
Intermediates should always present balanced
views, including any disadvantages and
downside risks of the recommended investment
products to their clients, and give them sufficient
time to consider and evaluate the information
and recommendations provided.
• Employing competent staff and
providing appropriate training
Intermediates should ensure products are
sold by staff members who have a sufficient
understanding of both the products and their
obligations to clients. It is also important to ensure
that all staff members are properly trained in
carrying out their roles.
• Documenting and retaining the
rationale for each recommendation
Intermediaries should document and provide a
copy to each client of the rationale underlying
their investment recommendations made to
the clients, including any queries raised by
their clients and the responses given to them.
Additionally, intermediaries should keep sufficient
documentation on all client transactions and the
related advice provided to clients.
Did the Market Players Follow the
Regulatory Requirements?
The SFC conducted a thematic inspection of selling
practices for 10 licensed corporations (LCs) and
summarized its findings in a report in October 2012
(hereafter called the “Thematic Report”). The inspected
LCs were mainly independent financial advisers, wealth
management affiliates of global financial institutions and
stock brokers.
The Thematic Report set out deficiencies and
weaknesses in the LCs’ conduct and selling practices
relating to the sale of investment products. Some of the
key findings are:
• Inadequate resources and procedures for the LCs
to supervise their staff diligently. In addition, there
is inadequate training for staff and insufficient
self-examination of controls and procedures to
ensure the LCs comply with all applicable legal
and regulatory requirements.
• Some LCs adopted risk-profiling questionnaires
while others asked clients to simply pick a risk
tolerance category from a number of options
in the account opening form but without
explanations. There was no certainty that the
client and the LC had the same interpretation
and understanding of the risk categories being
represented.
5. Mar-Apr 2013 37
prevent mis-selling in the past few years, and the focus is
more on investor protection.
He said the prevention of mis-selling is a priority for
regulators around the world. The SFC has been actively
working with the International Organization of Securities
Commissions (IOSCO) on this initiative. The focus will
be first to look into the creators of the financial products
aimed at individual investors; and secondly, to look into
the distribution channels to determine how to control
the behavior of sales people who coerce customers to
buy unsuitable products. Over the next 12 months, it
is expected that more proposals will be issued on the
prevention of misrepresentation of financial products to
retail investors.
On 14 December 2012, the Asia Financial Consumer
Protection Roundtable, jointly organised by the SFC,
the HKMA and the Organisation for Economic Co-
operation and Development (OECD), was held in Hong
Kong as the first high-level international conference on
financial consumer protection. Professor K.C. Chan,
the Secretary for Financial Services and the Treasury,
highlighted during the event that it is a policy objective of
the Hong Kong Government to strike a balance between
generating market development and enhancing financial
stability and protection.
Closing the Gap
Both the SFC and the HKMA have achieved much in
terms of putting into place preventive measures and
new requirements to control “mis-selling” practices in
the financial industry in Hong Kong. The SFC has also
pointed out in its Thematic Report last year that it will
take appropriate regulatory action against LCs found to
have breached the Code of Conduct and other applicable
requirements.
To close the gap between regulatory requirements and
sales practices, senior managers of intermediaries
should take immediate steps to review their existing
systems and practices in order to identify areas that may
be unfair or not in the interests of their clients. In this
way, they will ensure they are complying with the new
regulatory requirements.
ANNIE CHAN
Managing Director
Forensic and Investigation Services
Mazars Hong Kong
Some LCs did not conduct product due diligence on SFC-
authorized funds. In addition, some LCs did not conduct
any product due diligence themselves but merely relied
on the information available on a fund platform. The SFC
also found that there was inadequate documentation on
the due diligence work performed.
• Not all the inspected LCs require sales staff
to assess concentration risk by taking into
account their clients’ net worth. Some LCs do
not provide written guidelines to sales staff on
how a concentration risk assessment should be
performed.
• Some LCs only kept little documentation,
which was not sufficient to explain how the
recommendations were considered suitable having
regard to the clients’ personal circumstances. Even
if the sales staff kept their own notes regarding the
client’s circumstances and/or subsequent changes,
copies of the notes were not kept in the LCs’
records.
• Some LCs relied solely on a client’s declaration
of their derivative knowledge instead of carrying
out a proper assessment by making appropriate
enquiries or gathering relevant information from the
clients.
However, the SFC’s Thematic Report also provided some
examples of good practice concerning staff training,
the establishment of elaborate compliance monitoring
procedures, and additional controls set up for elderly
customers that have been adopted by certain LCs.
The HKMA also set out similar guidelines and
requirements for authorized institutions that are selling
investment products. Please refer to Table One below for
more details.
Helping Investors Make Informed
Decisions
The Investor Education Center, a subsidiary of the SFC
was established on 20 November 2012 to help investors
become better equipped to make informed financial
decisions and manage their money wisely.
Ashley Alder, the chief executive of the SFC, said in the
third annual Pan-Asian Regulatory Summit held on 27
November 2012 that Hong Kong has achieved much to
