Consultation Paper on Proposed Amendments to Hong Kong Professional Investor Regime-Industry Comments Due Mid-August 2013

Summary

The Hong Kong Securities and Futures Commission (“SFC”) issued a consultation paper entitled Consultation Paper on the Proposed Amendments to the Professional Investor Regime and the Client Agreement Requirements on 15 May 2013. Industry participants have been invited to submit comments by 14 August 2013. The consultation paper outlines the following proposals to amend the professional investor regime in Hong Kong:

• The introduction of a requirement that all category B professional investors (as defined below) who are individuals, their wholly owned investment vehicles and investment vehicles owned by family trusts be treated as non-professional investors for the purposes of the Code of Conduct for Persons Licensed By or Registered with the Securities and Futures Commission (the “Code”). (The current position is that category B professional investors may be treated as professional investors for the purposes of the Code if they meet certain requirements as to their level of sophistication and understanding of the product sold);
• The possible amendment of the current monetary thresholds set out in the Securities and Futures (Professional Investor) Rules;
• That professional investors which are corporations may continue to be treated as professional investors for the purposes of the Code where they satisfy a principles based assessment of knowledge and investment experience and have given their consent to be treated as a professional investor;
• That the suitability requirements set out in the Code be incorporated into client agreements as a contractual term; and
• That intermediaries be prohibited from putting terms in client agreements which are inconsistent with the provisions of the Code.

Current position

A category B professional investor is a professional investor as defined in the Securities and Futures (Professional Investor) Rules (Cap. 571D) (the “Professional Investor Rules”) as follows:

“(a) Any individual who (either alone or with his/her spouse and child on a joint account) has a portfolio of not less than $8 million; 
 (b) Any trust corporation having been entrusted with total assets of not less than $40 million;
 (c) Any corporation or partnership having:
    (i)  A portfolio of not less than $8 million; or 
    (ii) Total assets of not less than $40 million;
 (d) Any corporation the sole business of which is to hold investments and is wholly owned by any one or more of (a), (b) or (c)  above.”

A “portfolio” is defined in the Professional Investor Rules as comprising any of the following:

“(a) Securities;
 (b) A certificate of deposit issued by:
    (i) An authorised financial institution; or
    (ii) A bank which is not an authorised financial institution but is regulated under the law of any place outside Hong Kong,
 (c) In relation to an individual, corporation or partnership, money held by a custodian for the individual, corporation or partnership.”

Category B professional investors who meet certain sophistication criteria currently may be treated as professional investors for the purposes of the Code which means that certain obligations to such investors (for example the obligation to conduct a suitability test and enter into a client agreement) may be dispensed with. The intermediary is currently obliged to have regard to the following criteria when assessing the level of sophistication of the category B professional investor:

(a)  The type of products in which the person has traded;
(b)  The frequency and size of trades (not less than 40 transactions per annum);
(c)  The person’s dealing experience (active in the relevant market for at least 2 years);
(d)  The person’s knowledge and expertise in the relevant products; and
(e)  His awareness of the risks involved in trading in the relevant products and /or markets.

Such investors must consent in writing to being treated as professional investors for the purposes of the Code and must confirm this consent on an annual basis. They may revoke their consent at any time. The SFC acknowledges that intermediaries are not expected to apply the above criteria rigidly.

The implementation of the proposed changes would result in this sophistication test being abolished and replaced by a principles based test in respect of corporate professional investors only. There would, if the proposed changes are introduced, be no circumstances in which category B professional investors who are individuals, corporations that operate as investment vehicles wholly owned by individuals and by family trusts would be subject to a sophistication test. Instead, all of the Code requirements, including the requirements regarding investor suitability will be automatically applied to such investors.

Suitability requirement

The SFC views the suitability requirement, being the requirement to ensure that the suitability of a recommendation of an investment product for a client or a solicitation is reasonable in all circumstances, as being a pivotal component of protecting investors.
 
Presently, the suitability requirement is only a regulatory requirement and the SFC cannot require intermediaries to pay compensation to aggrieved clients who have not had the benefit of the suitability requirement analysis. Further, breaches of the Code do not enable clients of an intermediary to claim compensation or bring any other claims.

Accordingly, in addition to proposals outlined above, the SFC is proposing to amend the client agreement requirements in the Code in order to address these concerns. The SFC is proposing that intermediaries be obliged to incorporate the suitability requirement into client agreements as a contractual term and a requirement that client agreements must not contain terms which are inconsistent with the Code and should accurately set out in clear terms the actual services to be provided to the client.

Contacts

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