Mis-selling of financial products has become a concern in recent years, especially after the Lehman Brothers incident in 2008. There is also an increasing concern for the sale of financial products to a “professional investor”, which allows certain requirements of the “Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission” (the “Code”) to be dispensed by intermediaries. In view of these concerns, the Securities and Futures Commission (“SFC”) conducted two public consultations on proposed amendments to the professional investor regime and client agreement provisions in May 2013 and September 2014 respectively. This article will discuss the key changes to the professional investor regime in Hong Kong after these consultations.
Who are Professional Investors?
Professional investors, as the name suggested, refer to sophisticated investors with sufficient investment experience and knowledge. It is defined in section 1 of Part 1 of Schedule 1 of the Securities and Futures Ordinance (Cap 571) and generally includes:
- any individual who (either alone or with his/her spouse or child on a joint account) has a portfolio of not less than $8 million (or its equivalent in any foreign currency) (“Individual Professional Investor(s)”);
- any trust corporation having been entrusted with total assets of not less than $40 million (or its equivalent in any foreign currency);
- any corporation or partnership having (a) a portfolio of not less than $8 million (or its equivalent in any foreign currency); or (b) total assets of not less than $40 million (or its equivalent in any foreign currency); and
- any corporation the sole business of which is to hold investments and is wholly owned by any one or more of the Individual Professional Investors or such persons described in 2 or 3 above.
Categories 2 to 4 are also classified as “Corporate Professional Investor(s)”. 2
Key Changes to the Professional Investor Regime
Rationale for Changes to the Professional Investors Regime
Individual Professional Investors are individuals with high-net-worth portfolios. Corporate Professional Investors are corporations with high-valued assets. Both types of investors may not necessarily be experienced in making investment decisions. The amendments to the Code intend to provide greater protection to these two types of investors.
Professional Investors’ Exemptions under the Code
Prior to 25 March 2016, the date on which the amendments to the Code took effect, for all Individual Professional Investors and Corporate Professional Investors that met with the requirements of the Old Professional Investors’ Assessment (as explained further below) and signed status confirmation statements to confirm the status of professional investor for the purpose of the Code, intermediaries are not obliged to comply with:
- the requirement to ensure that the suitability of recommendation or solicitation made by the intermediaries for the client is reasonable in all the circumstances (the “Suitability Requirement”);
- the need to establish a client’s financial situation, investment experience and investment objectives;
- the need to assess a client’s knowledge of derivatives and characterise the client based on his knowledge of derivatives;
- the need to disclose certain transaction-related information;
- the need to enter into a written agreement and the provision of relevant risk disclosure statements; and
- for discretionary accounts, the need to obtain from the client an authority in written form prior to effecting transactions for the client without his specific authority, the need to explain the authority and the need to confirm it on an annual basis.
The above exemptions set out in 1 to 6 above (the “Professional Investors’ Exemptions”) are no longer available to certain types of Professional Investors after the Code amendments took effect.
Fewer Exemptions for Certain Types of Professional Investors
With effect from 25 March 2016, Individual Professional Investors will be treated as non-professional investors, regardless of the level of knowledge, expertise and investment experience of such individuals in relevant products and markets. Intermediaries will be required to comply with all Code requirements without exemptions to any of the paragraphs listed under the Professional Investors’ Exemptions when dealing with Individual Professional Investors. 3
For Corporate Professional Investors, with effect from 25 March 2016, intermediaries may continue to treat them as professional investors only if such Corporate Professional Investor:
- fulfil the criteria in the Revised Corporate Professional Investors’ Assessment (as explained further below); and
- consent in writing to the Professional Investors’ Exemptions being applied in respect of it. This confirmation exercise must be carried out annually.
Exemptions Other than the Professional Investors’ Exemptions
In respect of other Code exemptions which are more administrative in nature, will remain available to intermediaries when serving all professional investors (including Individual Professional Investors). They include:
- the need to inform the client about itself (e.g., information about its business including contact details, services available to clients) and the identity and status of its employees and others acting on its behalf;
- the need to confirm promptly with the client the essential features of a transaction after effecting a transaction for a client; and
- the need to provide the client with documentation on the Nasdaq-Amex Pilot Program.
Intermediaries are still required to explain the risks and consequences of these Code exemptions in 1 to 3 above to the professional investors and obtain written consent. This confirmation exercise must be carried out on an annual basis, to remind the investors of the risks and consequences of being treated as a professional investor and their right to withdraw from being so treated.
Revised Corporate Professional Investors’ Assessment
Prior to the Code amendments, intermediaries assess professional investors by way of some bright line tests (the “Old Professional Investors’ Assessment”) with 5 factors such as the investor’s experience in the type of product, frequency and size of trading, dealing experience, knowledge and expertise, and awareness of risks in trading in the relevant products to determine whether the Professional Investors’ Exemptions can be applied.
With effect from 25 March 2016, a principles-based assessment (the “Revised Corporate Professional Investors’ Assessment”) is used instead for Corporate Professional Investors as it is recognized that the factors used by the Old Professional Investors’ Assessment may not be good indicators of the knowledge and investment experience if taken in isolation.
Under the Revised Corporate Professional Investors’ Assessment, 3 criteria need to be satisfied: 4
- the Corporate Professional Investor has an appropriate corporate structure and investment process and controls;
- the person(s) responsible for making investment decisions has(have) sufficient investment background; and
- the Corporate Professional Investor is aware of the risks involved.
Amendments to Client Agreements
In the amendments provided by the SFC after the second consultation, the following clause has to be incorporated into the client agreements as a contractual term (the “New Clause”):
“If we [the intermediary] solicit the sale of or recommend any financial product to you [the client], the financial product must be reasonably suitable for you having regard to your financial situation, investment experience and investment objectives. No other provision of this agreement or any other document we may ask you to sign and no statement we may ask you to make derogates from this clause.”
The New Clause embraces the same concept as the Suitability Requirement, but rather than imposing a regulatory obligation under the Code, it creates a contractual obligation under the client agreements. This enables investors to claim compensation from intermediaries for breach of contract. The last part of the New Clause contains a non-derogation component to ensure that the client agreement does not contain any disclaimers or terms that would be inconsistent with the New Clause or override other provisions of the Code.
All new client agreements must contain the New Clause. All existing client agreements have to be reviewed, updated and re-executed to ensure the New Clause is added. An 18-month transitional period from 8 December 2015 is given to intermediaries to effect this change.
SFC is using its best endeavours to amend the professional investor regime to offer more protection to investors. A separate internal study of the Suitability Requirement is ongoing with a view to giving further guidance on the Suitability Requirement (e.g. when is it triggered and what amounts to “solicitation” or “recommendation”). While taking steps to comply with the revisions to the Code, intermediaries should watch out for the guidelines on the Suitability Requirement which may be released soon. 5
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|Important: The law and procedure on this subject are very specialised and complicated. This article is just a very general outline for reference and cannot be relied upon as legal advice in any individual case. If any advice or assistance is needed, please contact our solicitors.|
|Published by ONC Lawyers © 2016|