SFC consults on proposed guidelines on online distribution and advisory platforms

On 8 May 2017 the Securities and Futures Commission (SFC) issued its long anticipated consultation paper on the above subject, requesting comments by 4 August 2017.

As in many other jurisdictions, the question of how to encourage the development of online distribution advisory platforms whilst protecting the interests of investors, and how to fit them into the current regulatory framework, has been exercising the minds of industry participants and regulators for some years.

The issues for distribution platforms in Hong Kong are complicated by the fact that certain conduct obligations, and in particular the requirement to match products offered with investors’ needs and circumstances (the Suitability Requirement), applies in Hong Kong both where there is a solicitation and where there is a recommendation. In many other developed jurisdictions where a Suitability Requirement is imposed, it applies only where there is a personal recommendation of a financial product. “Solicitation” is a very broad term – it has been argued that the mere display of offering documents or marketing materials amounts to a solicitation triggering the Suitability Requirement.

Online platforms enable transactions to take place without any interaction between an investor and a sales representative. Investors can simply select and purchase a product based on the information and materials posted on the platform.

This new business model brings new opportunities as well as risks. The SFC proposes to introduce a set of specific guidelines (Proposed Guidelines) applicable to all SFC-licensed or registered persons when conducting their regulated activities in providing order execution, distribution and advisory services in respect of investment products via online platforms (Platform Operators). The Proposed Guidelines aim to provide tailored guidance and clarity on the design and operation of online platforms in compliance with existing regulatory requirements (including the Suitability Requirement), with additional protective measures proposed for the sale of complex products on online platforms.

The Proposed Guidelines focus on the following three main areas:

Governance and controls

These mainly concern the governance and controls expected to be put in place by a Platform Operator with specific guidance on the provision of automated or robo-advice on an online platform.

Suitability Requirement

The SFC aims to clarify how the Suitability Requirement would operate in the context of an online platform, in terms of when it will be triggered and how it may be discharged.

The Proposed Guidelines will clarify that the posting of factual, fair and balanced materials on online platforms would not in itself amount to a solicitation or recommendation and will not trigger the Suitability Requirement. This recognises that in the absence of interaction between a sales representative and an investor, the Suitability Requirement is unlikely to be triggered by the mere posting of an advertisement for an investment product on a website or internet platform, or in other media such as in newspapers, magazines or television programmes. The SFC takes the same approach with regard to the wide dissemination of research reports.

However, robo-advice would normally include a solicitation or recommendation and thereby of itself trigger the Suitability Requirement.

Additional protective measures for the sale of complex products on online platforms on an unsolicited basis

The third part of the Proposed Guidelines sets out certain additional requirements applicable to the sale of complex products on an online platform in circumstances where no solicitation, recommendation or advice has been provided, where investors would not be protected by the Suitability Requirement under the current regulatory framework.

Complex products refer to products whose terms, features and risks are not reasonably likely to be understood by retail investors because of their structure (as opposed to more traditional or “plain vanilla” investment instruments), and which are difficult to value (i.e., valuations require specific skills and/or systems, particularly when there is a very limited or no secondary market).

The SFC proposes to extend the Suitability Requirement to provide protection to investors in the sale of these complex products. The SFC notes that this is generally in line with recommendations made by IOSCO. It follows the trend of a number of regulators, including the SFC, in imposing conduct obligations on the issuers of financial products to take into account the needs, circumstances, knowledge and experience of their target investors when designing such products.

Written comments on the proposals discussed in the consultation paper should be submitted to the SFC by no later than 4 August 2017.