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SFC’s first compliance bulletin focusses on “egregious” conflict failures

“The SFC will not tolerate intermediaries treating clients unfairly or benefiting at the expense of clients’ interests.”

The SFC published the first issue of its Compliance Bulletin on 19 December 2017 as part of its “efforts to enhance communication with Managers-in-Charge”; and chose to focus on four supervisory cases identified in on-site inspections and off-site monitoring which “[highlight] the importance of managing conflicts of interest in selling practices and asset management”.

The SFC added at the end that it was investigating and “where appropriate” would take enforcement action against the intermediaries and Managers-In-Charge concerned in these cases.

General Principle 6 (which requires that conflicts be avoided or where they can’t be avoided, that clients be fairly treated), and paragraph 10.1 (which requires that where an intermediary has an interest in a transaction for a client etc, the conflict be disclosed to the client and that the client be treated fairly) of the SFC Code of Conduct (Code) were both reproduced in full in the bulletin.

Four supervisory conflict of interest cases:

  • Managing private funds

The SFC started by describing the recent growth in the number of asset managers in Hong Kong and from there discussed the case of a fund manager which had invested in concentrated positions of illiquid stocks and then arranged unfair loans from other funds and favourable loans from a director of the fund. This case had already been discussed in detail by the SFC in its circular of 31 July 2017, which was then referred to again in its 15 September 2017 circular (which described poor asset management practices it had observed) so this must be a heralding of enforcement actions to come.

  • Rebates

A private fund manager was passing 80% of its trades for a fund it managed to execution brokers which were rebating up to 85% of their commissions back to the fund manager. These cash rebates are fund assets and therefore belong to fund investors so full disclosure, consent and ongoing reporting to investors are required under the Fund Manager Code of Conduct (FMCC). The Fund Manager was unable to explain to the SFC why they happened to direct so many trades to these brokers and the SFC was concerned that the manager may have traded more frequently than necessary in order to generate the rebates. This case was also discussed in the SFC’s 15 September 2017 circular.

  • Selling practices

On an inspection the SFC noted that a firm had put itself into a position of conflict by selling the same bonds to different investors on the same day and taking a higher placing commission for those bonds with a lower coupon rate.

  • Selling “in-house” products

The SFC (and the HKMA) conducted joint thematic reviews of large financial groups which both manufacture and sell (usually banks) financial products though different legal entities and found that some banks:

    • sold structured products issued by related entities without comparing prices from outside counterparties, without disclosing the conflict and without transacting the client order at the best price available in the market;
    • relied completely on product due diligence work done by a (conflicted) group asset manager on a third party product;
    • did not disclose the availability of lower fees and charges offered by the product manufacturer, to their investors;
    • invested discretionary client funds heavily in “in-house” products.

These observations about the inherent conflicts involved when banks sell investment products were highlighted in the SFC’s 24 November 2017 circular, as discussed in our December publication.

Conflicts have always been an area of concern for the SFC, and this bulletin shows that identification of conflicts and appropriate handling thereof is the top priority for the SFC so firms should examine their controls in this regard and seek advice if necessary.

The bulletin is available via these links: English versionChinese version.

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