SFC Proposals to Enhance Investor Protection

Last week SFC released the Consultation Paper on Proposals to Enhance Protection for the Investing Public as the regulatory response to last year's financial crisis triggered by the collapse of Lehman Brothers.

This consultation is premised on Hong Kong continuing to adopt the "disclosure-based approach" coupled with conduct regulation on intermediaries who sell products. It proposes additional measures to provide investor protection, which are briefly summarized and commented below.

Documentation

• The criteria for authorizing offering documentation and advertisements will be consolidated into a single SFC handbook, covering unit trusts/mutual funds, ILAS and unlisted structured products. (Comment: It is desirable to provide a Code for unlisted structured products, but would it be as comprehensive as the UT Code?)
• SFC is working with Government to bring forward legislative amendments to transfer the authorization of offering documentation in relation to structured products out of the CO prospectus regime. (Comment: Actually this issue had been consulted and concluded a few years before. Why is SFC still working with Government?)
• All offering documents should include concise and easily-understood summaries, or product Key Facts Statements. (Comment: That's good for investor education. Such product KFS may be produced by SFC for standardization.)

Disclosure

• There are various options to address potential intermediary conflicts of interest issues regarding monetary and non-monetary benefits received. (Comment: Disclosure of commission rebates received by intermediaries from product issuers to the clients could at least partially resolve the conflicts of interest issues.)
• The single SFC handbook requires ongoing disclosure to investors of material information in relation to unlisted structured products in addition to the existing ongoing disclosure requirements already imposed on unit trusts/mutual funds and ILAS. (Comment: Ongoing disclosure is particularly important for long term unlisted structured products.)
• Distributors of these products are obliged to pass on to ultimate investors the information that they receive from the issuers. (Comment: Simply "passing on" the information may not be enough. Distributors should highlight material issues to the clients.)
• The minimum content to be provided in a sales disclosure document is specified. (Comment: Standardization of content in sales disclosure documents is necessary.)

Sales Process

• An intermediary should not act in a way that distract the client's attention from the product features by offering certain types of gifts as a marketing tool. (Comment: Actually this is the problem of retail investors. Even though product specific gifts are prohibited, intermediaries may still offer account specific gifts depending on the sales turnover.)
• Audio recording requirement should be extended to cover all intermediaries selling investments to the public. (Comment: Implementation of audio recording by intermediaries meeting with clients outside office is a difficulty. It may be more feasible for audio recording only the deal closing stage.)
• Intermediaries should only promote unlisted derivative products to clients (other than professional investors) who have been characterized as "clients with derivative knowledge". (Comment: The more objective way to characterize clients with derivative knowledge is asking them to pass an assessment quiz.)
• The minium portfolio requirement and the ways of assessing the knowledge, expertise and investment experience of a professional investor in a relevant market/product should be adjusted. (Comment: Increasing minimum portfolio requirement is of no use. SFC should give more guidelines for intermediaries to assess a PI's knowledge or experience in a so-called "relevant" market/product.)

Post-Sale Arrangements

• Cooling-off period should only be considered for products where the investment is long-term, and where there is no ready (and realistic) secondary market. (Comment: This requirement creates operational difficulties. Product issuers might have to delay the investment/trading process to cater for the refund request.)

This consultation has raised a number of controversial issues with far-reaching impact on intermediaries selling investment products. It is anticipated that SFC will receive a large amount of comments or counter-proposals.