Regulation

Hong Kong: Compliance Clarity on Sales of Investment Products


By Lam Wing Wo, Partner, Deacons, Hong Kong (01/01/2013)

The Hong Kong Monetary Authority (HKMA) has clarified the applicability of regulatory requirements on sales of investment products to (a) corporate customers and (b) investment products that are not regulated by the Securities and Futures Ordinance (SFO).

Corporate Customers

Corporate banks should adopt the enhanced measures on sales of investment products (which are applicable to private banking customers as set out in the HKMA’s circular of 20 January 2012) to corporate customers.

‘Large / sophisticated’ corporate customers are exempt. Such customers include a listed company, a company having a dedicated / specialised investment function, a trust and a professional partnership in law, accounting, taxation, actuary and finance.

Hedging transactions are also exempt, except in the case of ‘over hedging’. Further, whenever a corporate bank becomes aware that a transaction no longer serves a hedging purpose and becomes an investment, it is required to review the customer's position, draw to the customer's attention the fact that the customer has an exposure to the investment product, and take or recommend appropriate actions to address the situation.

The HKMA expects compliance by no later than 20 June 2013. Corporate banks are required to put in place adequate controls to ensure compliance with these regulatory requirements.

Non-SFO-regulated Investment Products

The HKMA expects authorised institutions (AIs), in selling investment products that are not regulated by the SFO (including but not limited to products that are linked to currencies or interest rates), to follow similar standards to those applicable to SFO-regulated investment products.

In particular, AIs should ensure suitability of their recommendations or solicitation, make proper disclosure of product features and risks to the customers, and ensure that their marketing materials are clear, fair and present a balanced picture.

The requirement under the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (SFC) concerning the use of gifts by distributors in promoting a specific investment product took immediate effect.

The requirements concerning investor characterisation, pre-sale disclosure of monetary and non-monetary benefits and the disclosure of sales related information are to be implemented by no later than 20 June 2013.

Fixed Income Products

The HKMA also decided to extend audio recording and pre-investment cooling-off period arrangements to certain fixed income products.

Audio Recording of Sale Process

AIs are required to audio-record the face-to-face sales to retail customers of (i) debentures which are extendable, exchangeable, convertible or with non-viability loss absorption feature, and (ii) investment funds primarily investing in high-yield bonds (which are generally below investment grade or are unrated). This is in addition to audio-recording of face-to-face sales to retail customers of debentures with features and risks that are different from other plain vanilla debentures, including debentures which are non-investment graded, unrated (for both the issue and the issuer), subordinated or perpetual.

If the sale is conducted by telephone, the telephone conversations should be audio-recorded. This requirement applies whether or not the customer is a retail customer.

Pre-Investment Cooling-Off Period Arrangement

AIs should apply a pre-investment cooling off period (PICOP) arrangement to the sale to ‘less sophisticated’ retail customers of debentures which are not listed on an exchange in Hong Kong and which are extendable, exchangeable, convertible (including contingent convertible) or with non-viability loss absorption feature (eg, bail-in).

‘Less sophisticated retail’ customers include the elderly and first time buyers of such debentures, with high concentration.

The HKMA expects the extension of the PICOP arrangement to such debentures to be implemented by AIs by no later than 19 May 2013.

The SFC notes that in the current low interest rate environment, investors strive for yield. Hence high-yield bonds, bonds with special features, and funds investing in high-yield bonds have found a ready market.

Intermediaries should observe the regulatory selling practice requirements, including under the Questions and Answers on Suitability Obligations issued by the SFC on 8 May 2007. Given the wide diversity in the features and risks of fixed income products, the SFC reminds intermediaries to put in place appropriate measures, systems and controls to ensure that their staff: 

  1. <!--[if !supportLists]-->   have a thorough understanding of such products;<!--[endif]-->
  2.    are able to explain to the client prior to or at the point of sale the key features and risks of the products and the implications thereof to the clients, and 
  3.    are familiar with the selling practice requirements.

Intermediaries are also reminded of their obligations to always present balanced views and not solely focus on advantageous terms such as high coupon rates or yields when recommending fixed income products to clients. Rather, intermediaries should also explain to the client the key features, disadvantages and downside risks.

Selling Practices

It may be recalled that when making investment recommendations or solicitations to clients, intermediaries are required to:

(a)        know their clients;

(b)        understand the investment products they recommend to clients. Product due diligence should be conducted on a continuous basis at appropriate intervals having regard to the nature, features and risks of investment products offered;

(c)        provide reasonably suitable recommendations by matching the risk return profile of an investment product to the personal circumstances of the client;

(d)        provide all relevant information to the client and help the client make informed investment decisions; 

(e)        document and retain the rationale underlying each investment recommendation and provide a copy to the client; and

(f)         employ competent staff and provide appropriate training (to ensure the staff have sufficient understanding of the products).


The management of an intermediary has primary responsibility for the development, implementation and on-going effectiveness of the firm’s internal controls, policies and procedures, as well as the adherence thereto by the firm’s staff. Among other things, intermediaries should have in place a compliance system that identifies, assesses, monitors, and responds to risks of non-compliance with regulatory requirements as well as with their own internal policies and procedures. Intermediaries should also regularly review the adequacy and effectiveness of their controls and procedures.

The deficiencies in selling practices identified by the SFC in its recent thematic inspection of the selling practices of licensed corporations include:

  •   failure by a supervisory officer to detect transactions involving a risk mismatch (ie, the risk rating of the investment product was higher than the risk profile of client);
  •    inadequate supervision which fails to ensure that sales staff properly maintain documentation of the rationale underlying their investment recommendations;
  •   no written guidelines on how to conduct suitability assessments based on the overall risks of the clients’ portfolios of investments;
  •   no compliance monitoring procedures to ensure that sales staff follow the firm’s suitability policies and procedures when making investment recommendations to clients;
  •   no explanations for the risks represented by each risk tolerance category, and no descriptions of the common traits of individuals in the different risk tolerance categories;
  •   treating bonds above investment grade as suitable for all clients. Treating funds with a risk rating of three or below (on a scale of five) as suitable for all clients;
  •   considering an investment as acceptable where its risk rating is higher than the client’s risk profile, because it represents a percentage of the client’s net worth lower than a specified threshold, without considering the risk ratings of any investment products already held in the client’s portfolio;
  •   using disclaimers, or asking clients to sign declarations or acknowledgements, which restrict the effect of certain investor protection measures under the Code of Conduct, which may be contrary to General Principle 1 of the Code of Conduct;
  •   giving the highest possible rate of rebates that the product providers might pay to the firm among all products distributed, and not the actual rate of rebate earned on the particular transaction;
  •   relying solely on client’s declaration that he has attended training or has prior working experience or trading experience relating to derivative knowledge, without making appropriate enquiries or gathering relevant information.

The SFC says that taking into account all relevant facts and circumstances, it will take appropriate regulatory action against the licensed corporations the subject of the inspection which are found to have breached the Code of Conduct and other applicable requirements. It would, therefore, be timely to review your policies, procedures and documentation to ascertain if there are any issues and, if necessary, to address them.