HK Regulators Go Shopping

The Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority jointly commissioned a mystery shopping exercise on the selling practices of intermediaries (including investment advisory firms and brokerages) of unlisted securities and futures products. The findings were released in a circular on 24 May 2011. The exercise focused on compliance by the intermediaries in the areas of know-your-client (KYC), product feature explanation and risk disclosure, and suitability assessment. Where major deficiencies were noted, the SFC has required the firms to take action. The SFC stated in the report that it would not hesitate to take regulatory action for repeated material breaches.

The findings reveal that the KYC process was often not properly conducted. In order to be able to offer a wider range of products to clients, sales staff sometimes guided or hinted to clients to change their answers in the investor risk profile questionnaire. In some instances investors were not asked about investment horizon or risk appetite before investment products were recommended and in other cases, sales staff did not address clients’ enquires properly. The message from the SFC is that the KYC process needs to take all of a client’s relevant personal circumstances into account including investment horizon and risk appetite; that it must be made clear to sales staff that they should not ask clients to change any of their answers to questions; and that if they cannot address a question from a client properly, they need to seek assistance.

The findings also identified deficiencies in the overall quality of product feature explanations and disclosure of risks. Some sales staff did not possess sufficient understanding of, or were unable to provide sufficient information concerning, investment products they had recommended. This serves as a timely reminder to the industry of the importance of conducting staff training sessions at frequent intervals. Such training should be conducted not only when sales staff ask for it, but also when management determines it is required so that a firm can demonstrate to the SFC that it has a robust compliance training programme in place.

Finally, despite the highly publicised fall-out from the Lehman mini-bond crisis in Hong Kong, deficiencies in suitability assessments continue. Some sales staff failed to provide a clear rationale for product recommendations, even where the risk level of an investment product was higher than the client’s risk appetite or tolerance. Intermediaries need to have clear procedures designed to help staff to conduct the sales process properly. Firms also need to conduct training sessions on the procedures and forms and make other staff available to answer questions as they arise.

The circular notes that many good selling practices were also identified in the mystery shopping exercise. Some sales staff advised clients to diversify their investments while others exercised extreme care in dealing with elderly or young clients.