SFC licensing and compliance hints: Are you ready for the new suitability and complex product requirements?

On 13 June 2019, the Securities and Futures Commission (SFC) issued additional Frequently Asked Questions (FAQs) on the Guidelines on Online Distribution and Advisory Platforms (Guidelines) and paragraph 5.5 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Code of Conduct). Both will be effective on 6 July 2019.

The additional FAQs (numbers 35 – 38) aim to clarify the application of the new paragraph 5.5. of the Code of Conduct (New CoC Requirements), in the situation where an intermediary provides execution services; finances clients to purchase investment products; and operates under an external asset manager and shared relationship model, as further discussed below.

Intermediaries should review their compliance infrastructure for services involving complex products so as to comply with the Guidelines and New CoC Requirements.

New CoC Requirements

Under the new paragraph 5.5(a) of the Code of Conduct, an intermediary will need to ensure the following when providing services to a client in complex products, unless the complex products are derivative products traded on an exchange in Hong Kong or in a specified jurisdiction

  • The transaction in a complex product is suitable for the client in all the circumstances.
  • Sufficient information on the key nature, features and risks of the product is provided so as to enable the client to understand the product before making an investment decision.
  • Warning statements in relation to the distribution of the product are provided to the client in a clear and prominent manner.

Execution vs. sales / recommendations / discretionary services

The existing Code of Conduct already imposes suitability obligations on an intermediary to ensure the products (whether complex or not) that it solicits, recommends, or the discretionary services it provides, are suitable for a client (other than an institutional professional investor and eligible corporate professional investor).

The New CoC Requirements will apply where an intermediary executes a transaction in a complex product for a client without making any solicitation or recommendation in respect of the transaction (i.e. the client purchases the complex product on an unsolicited basis).

Securities margin financing

A typical securities margin financing transaction involving Hong Kong listed shares (which are non-complex products) will not trigger the New CoC Requirements.

Under the existing Code of Conduct, an intermediary has an obligation to ensure that its clients understand the nature and risks of leveraging and have sufficient net worth to be able to assume the risks and bear the potential losses of leveraged transactions.

External asset management and shared relationship

The New CoC Requirements will not apply to an intermediary providing execution and/or custody services (Execution Broker) for the accounts managed or advised by another intermediary if:

  • the other intermediary is licensed in Hong Kong or regulated in an overseas jurisdiction for providing investment advisory or discretionary management services (Investment Advisor or Manager) for the accounts of its clients;
  • the Investment Advisor or Manager is responsible for the compliance of the applicable requirements either in its own jurisdiction (if it is an overseas regulated entity) or under the Code of Conduct (if it is an SFC licensed corporation), before transmitting orders for the accounts it manages or advises, to the Execution Broker;
  • the Execution Broker merely provides execution and/or custody services to the accounts and does not have day-to-day contact or direct communication with the clients of the accounts; and
  • clients of the accounts are informed of the above arrangements.

Disclosure of product information

Under the existing requirements, an intermediary needs to explain the nature and extent of risks of an investment product, when soliciting or recommending it.

Effective 6 July 2019, additional product information and warning statements need to be provided to so as to draw the investors’ attention to the key nature, features and risks of complex products.

The SFC generally expects an intermediary to provide warning statements to a client for each transaction for a complex product. However, an intermediary is allowed to take a risk-based approach for repeated transactions by a client in respect of the same product, provided that it can reasonably be satisfied that the client has sufficient understanding of the product having regard to the following factors:

  • the client’s trading pattern, level of sophistication and investment experience;
  • product complexity and risk in providing disclosure to the client; and
  • adequacy and validity of previous disclosure the client.