Licensing Requirements for Selling ILAS

Last week SFC issued a circular to clarify the licensing requirements arising out the promotion, offering or sale of investment-linked assurance schemes (ILSA) by insurance intermediaries (agents and brokers) to the public.

Regulated activities relating to the sale of ILAS are Type 1 (dealing in securities) and Type 4 (advising on securities). ILAS by itself is defined as a collective investment scheme (CIS) but excluded from the definition of "securities" under SFO. The question is whether advising clients acquiring ILAS on the selection of underlying funds would constitute dealing in securities or advising on securities.

In its circular, SFC highlights that premium payments made by ILAS policyholders are first applied in respect of fees and commissions, with the balance being paid to the insurer and notionally invested in the underlying funds specified by policyholders. Although it is the performance of these underlying funds that determines the value of the ILAS policy from time to time, the policyholder's premium payments are not invested in these underlying funds for them. Instead, these investments, if made, are for the account of the insurer itself.

SFC takes the view that advising or making recommendations to policyholders concerning the selection by them of the underlying funds of ILAS, does not constitute advising on securities, even if those underlying funds are securities. The reasons are as follows:

• Advising on securities, within the meaning of SFO, is concerned with advice relating to the acquisition or disposal of securities by the person being advised. In the case of ILAS, the underlying funds are not acquired or disposed of.
• Advice given to ILAS policyholders is only concerned with selection of underlying funds whose performance will notionally be used to calculate the value of the ILAS policy from time to time.

SFC also takes the view that promoting, offering or selling ILAS to the public (including giving advice to policyholders concerning selection of underlying funds) does not constitute dealing in securities, which is defined as making an agreement with another person or inducing another person to enter into an agreement (a) for acquiring, disposing of, subscribing for or underwriting securities; or (b) the the purpose of which is to secure a profit from the yield of securities or by reference to fluctuations in the value of securities. The reasons are as follows:

• Units in ILAS are not securities.
• Underlying funds of ILAS are not acquired or disposed of for the policyholders.
• It can't be said that the purpose (or even the dominant purpose) of acquiring an ILAS policy is to secure a profit from fluctuations in the value of underlying funds.
• SFO definition of dealing in securities excludes the issue of any advertisement, invitation document authorized by SFC.

Even if advising concerning ILAS underlying funds were regarded as advising on securities or dealing in securities, SFC considers that there would be no carrying on of a business in these regulated activities. This is because advising concerning ILAS underlying funds:

• does not stand alone as a discrete business carried on its own right
• by itself does not generate any financial gain
• appears to occur haphazardly
• does not indicate the existence of an established and ongoing business principally involving that particular activity

Two important implications could be derived from this circular. First, insurance intermediaries would no longer be regulated by SFC when they are selling (or mis-selling) ILAS and advising (or mis-advising) ILAS underlying funds. Second, in future the number of licensed corporations and representatives would be substantially reduced because:

• Selling of direct funds (no matter by banks, brokers or so-called IFA) constitutes only dealing in securities, not advising on securities.
• Corporations / representatives licensed for Type 1 could advise on securities without Type 4 based on the "wholly incidental" exemption.
• Advising concerning ILAS underlying funds is no longer regarded as Type 4.

You may doubt whether this SFC circular is also relevant to promotion, selling or offering of MPF schemes (which are also regarded as CIS but not securities under SFO). My interpretation is that even selling of MPF schemes does not constitute Type 1, advising concerning constituent funds of MPF schemes may still fall within Type 4 because, unlike ILAS, constituent funds are acquired or disposed of for employee participants.

SFC had better issue a separate circular to clarify the licensing requirements for selling of MPF schemes. If MPF intermediaries were also exempt from licensing, then we may envisage that in future only equity research analysts need to be licensed for Type 4.