Hong Kong SFC Proposals to enhance investor protection released

Following the Lehman mini bond scandal in Hong Kong where large numbers of investors appear to have been sold inappropriate financial products, regulators have been going through a process of analyzing what went wrong in order to consider new procedures.  A short while ago the Hong Kong Monetary Authority, which regulates banks, set out a number of new rules for those institutions regarding sales and suitability.

Yesterday the Hong Kong SFC published its consultation paper for changes to the Hong Kong rules that govern securities and financial advisory firms that are regulated by it.  The SFC website states as follows:

The Securities and Futures Commission (SFC) has today begun a three-month consultation to solicit public comments on proposals to fine-tune existing regulations governing the sale of unlisted securities and futures products to the public.

Proposals contained in the consultation paper released today cover each stage of the investment life-cycle and are designed to enhance the current regulatory regime for the sale of investments to the public.

A review of the circumstances under which investors suffered losses upon the collapse of Lehman Brothers has highlighted concerns about how certain unlisted investment products have been sold to members of the public. Despite the overall resilience of Hong Kong’s financial infrastructure over the past 18 months, the failure of one of the world’s largest investment banks had led to early termination of a number of its products and significant losses for Hong Kong investors.

“It is important to distinguish the actions being proposed today, which is to enhance the existing regulatory regime for the sale of retail products, and the debate now taking place – globally, regionally and nationally – about what structural changes to regulation may be required to prevent a future financial crisis,” said Mr Martin Wheatley, the SFC’s Chief Executive Officer. “These are very different issues, requiring different considerations.”

“The changes we have proposed will enhance our regulatory regime but they must go hand in hand with strict compliance by institutions that sell investments to the public,” added Mr Wheatley. “Investors, on their part, must also be better equipped to take responsibility for their own decisions.”

The proposals follow from the SFC’s report to the Financial Secretary in December 2008 (Note 1) and are aimed at strengthening Hong Kong’s disclosure-based regulatory approach. Below are some key points (see also appendix):

• Pre-sale documentation
  - Criteria for authorising offer documents, including advertisements, should be consolidated into a single SFC Handbook.
  - A “Key Facts Statement” in the form of a concise and easily comprehensible summary should accompany each offer document for retail investment products.

• Disclosure at the point of sale and after
  - Intermediaries selling to the public should disclose their own commercial interest (e.g. commissions, fees and other benefits) to prospective investors.
  - On an ongoing basis intermediaries will be required to disclose material information related to long-term investments until their maturity.
  
  
• Selling practices
  - As part of the “know-your–client” process, intermediaries will be required to specifically gauge their clients’ knowledge of derivative products. This will be regarded as a prerequisite to selling unlisted structured products with such elements embedded.
  - Comments are being solicited on whether to extend the audio recording requirement imposed on banks by the Hong Kong Monetary Authority to all intermediaries or if the existing record keeping requirement remains sufficient.
  - The definition of “professional investor” is being reviewed not just in terms of the asset test but also in terms of product knowledge and investment experience.

• Post-sale cooling-off period
  - For longer-term products with a limited secondary market, a cooling-off period should be given within which an investor can change their mind. This should allow a refund capital and related commission, but be subject to a reasonable administrative charge and any legitimate market value adjustment.

The proposals will be complemented by separate consultations undertaken by the Government later in the year regarding an expansion of investor education and the establishment of a financial dispute resolution body.

To arrive at proposals for this consultation, the SFC has closely examined the regulatory regimes in major jurisdictions and informally consulted the industry. “We now invite all interested parties to submit comments so that we can take into account all viewpoints and determine the best course of action,” Mr Wheatley said.