Introduction
On 28 July 2023, the Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) published a joint circular, along with detailed guidance set out in Annex 1 thereto and the frequently asked questions in Annex 2 thereto, in relation to a new regime which allows intermediaries to apply a proportionate, risk-based streamlined approach (Streamlined Approach) for compliance with suitability obligations when dealing with sophisticated professional investors (SPIs).
One of the long-standing features of the Hong Kong regulatory regime has been the various investor protection measures, which include suitability obligations, being those requirements set out under paragraph 5.2 and 5.5(a) of the Code of Conduct for Persons Licensed by or Registered with the SFC to the effect that an SFC licensed or registered person (intermediaries) must ensure that any recommendation to, or solicitation for, a client, or a transaction involving complex products, is suitable for the client in all the circumstances.
SPIs are individual professional investors who satisfy certain criteria on net worth and possess certain knowledge or experience. In particular, an SPI must, at the relevant date, have a portfolio of at least HK$40 million or net assets of at least HK$80 million (or its equivalent in any other currency), and the requisite level of sophistication (either through holding a degree in accounting, economics or finance; having attained a professional qualification in finance; having at least one-year’s work experience in a professional position in the financial sector (whether in Hong Kong or otherwise); or having executed at least five transactions in the same category of investment products (based on their terms, features, characteristics, nature and extent of risks) (Product Category)) within the past three years.
The Streamlined Approach has generally been welcomed by the investment community and service intermediaries, as it gives greater flexibility to intermediaries, including but not limited to private banks, private wealth management firms and those engaged in the financial planning business, when dealing with SPIs. It will be particularly helpful in dealing with those they (and in many cases the SPI themselves) consider to have greater levels of sophistication, greater knowledge or experience and having a higher net worth, who they consider do not need as much investor protection as other investors with less experience, wealth or sophistication.
What does this mean for intermediaries?
KYC remains an important starting point
Despite the adoption of a Streamlined Approach, a robust know-your-client onboarding process remains essential for intermediaries to obtain information to better understand their clients, including their background, financial situation, knowledge, experience, risk appetite and investment needs, and thereafter to enable such intermediaries to assess whether the client has met the qualifying criteria for an SPI. In general, intermediaries may rely on the information disclosed by the client, but must still exercise diligence and consider any inconsistencies between the information provided by the client and that held with the intermediary, and clarify with the client where necessary.
Steps prior to implementing the Streamlined Approach
Upon receipt of the relevant information from a client during the know-your-client process, intermediaries must conduct an assessment to reasonably confirm that the investor qualifies as an SPI and has the requisite degree of sophistication needed to understand and sign itself up to the risks arising from the Streamlined Approach.
The SPI assessment should be in writing and properly documented.
Upon being reasonably satisfied that an SPI has the requisite level of sophistication and knowledge, the intermediary must duly obtain written consent from the potential SPI to it being treated as an SPI, and specify in writing the assessment criteria, the setting of the Product Categories and the “Streamlining Threshold” (being the maximum threshold of investment, as an absolute amount or a percentage relative to the SPI’s assets under management (AUM) with the institution, that is acceptable to the SPI under the Streamlined Approach) in accordance with paragraphs 7 and 8 of Annex 1, within which investments transactions of the SPI could be executed under the Streamlined Approach. The transactions that fall within the relevant “Product Categories” and the “Streamlining Threshold” are referred to as the “Eligible Investment Transactions”, which are the only investment transactions that intermediaries should execute for an SPI under the Streamlined Approach.
Intermediaries must also explain to an SPI the consequences of being treated as an SPI, which includes, among other things:
- that compliance with suitability obligations procedures when dealing with SPIs in Eligible Investment Transactions could be streamlined (see details below);
- that point-of-sale procedures within the institution will be streamlined whereby the SPI may end up investing in a portfolio of high-risk investment products on both a solicited and unsolicited basis (see details below); and
- by specifying a Product Category and Streamlining Threshold within which investment transactions could be executed under a Streamlined Approach, the SPI acknowledges having the requisite knowledge and experience to understand the product characteristics and the extent of risk associated with the relevant investment transactions.
Simplified point-of-sale process
Intermediaries also then benefit from greater flexibility and a simplified point-of-sales process.
For example, in relation to transactions executed under a Streamlined Approach involving either investment products with a recommendation or solicitation or those involving a complex product without a recommendation or solicitation, intermediaries like private banks, wealth management firms and other financial planning service providers are no longer required to match the SPI’s risk tolerance level, investment objectives and investment horizon with the Eligible Investment Transactions, nor are they required to assess the SPI’s knowledge, experience and risk concentration in the Eligible Investment Transactions. Intermediaries are also not required to provide a product explanation for an Eligible Investment Transaction, subject to any requests and/or material queries raised by the SPI. Furthermore, intermediaries may have offering documents sent to SPIs by circulating the relevant hyperlinks to offering documents to them or via electronic means to satisfy their obligation to provide up-to-date offering documents to SPI.
Moreover, for transactions involving a complex product without any recommendation or solicitation, intermediaries are not required to perform product due diligence for investment products (that are complex products) which fall within the Product Categories specified by the SPI subject to the provision of offering documents to the SPI. Intermediaries should, however, also note the special requirements for bonds that are complex products.
The combined effect is to simplify the point-of-sale procedures for SPIs and could potentially result in more targeted and efficient marketing of products to SPIs, as well as a more tailored experience for SPIs who may feel that they understand the risks with the products and do not need the same level of explanation or protection.
Having in place proper system and control
Intermediaries do, however, need to bear in mind that they remain accountable for ensuring that appropriate systems and controls are implemented to properly manage the Streamlined Approach, and must remain in compliance with the relevant standards of conduct imposed by the regulators. The new lighter touch regime for SPIs does not mean that it can manage itself or that other standards can be lowered.
Thus, intermediaries must ensure that measures are in place to ensure compliance with the Streamlining Threshold: in particular, to either ensure the gross exposure arising from investment transactions executed under the Streamlined Approach remains at or below the Streamlining Threshold upon execution, or they can devise designated accounts (or sub-accounts) to consolidate Eligible Investment Transactions of the SPI executed under the Streamlined Approach. Appropriate prevention measures should also be implemented to detect any major red flags (such as outsize or material transactions) and issue warning statements to SPIs for those transactions.
As a next step, to maintain their competitiveness in the market, intermediaries need to review their current policies and update their systems, control measures and internal policies to ensure compliance with both the new regime and the relevant standard of conduct rules.
Intermediaries should also conduct annual reviews to ensure continuous compliance with the requirements, and shall send written reminders to SPI clients covering, among other things, the right of SPIs to withdraw from being treated as such, and their right to vary any Product Category and/or Streamlining Threshold at any time to take account of changed circumstances new or emerging risks and so forth.
Next steps
Clients of private banks, wealth management firms, financial planning service providers and other intermediaries cover a wide spectrum of investors. The Streamlined Approach aims to clarify the types of investors that fall within the definition of SPIs, and delineate the simplified process that relationship managers and private wealth managers may apply when formulating investment portfolios for their SPI clients, whether on a solicited basis or not.
That said, not all clients will qualify as SPIs – hence all financial planning service providers still need to make sure that they correctly categorize clients when carrying out any initial client onboarding and sales. In particular, intermediaries need to review their existing assessment protocols, controls and procedures to ensure that they can offer a more enhanced client experience to those investors who are identified as SPIs, whilst ensuring that they continue to deploy sufficient resources and people to meet the needs of other investors who do not qualify and who are not affected by the new regime.
Authored by Andrew McGinty and Vanessa Kwok.
