Protection for Investors and Structured Products
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IV. New Measures Added to Various Ordinances to Enhance Protection for Investors

The SFC has introduced amendments to its Code of Conduct for Persons Licensed by or Registered with the SFC (“the Code of Conduct”) to enhance protection for investors. The four major aspects of these amendments are: (a) investors characterization; (b) pre-sale disclosure of monetary and non-monetary benefit; (c) disclosure of sale related information; and (d) refund by distributors under a cooling-off period.



(a) Investors Characterization

Under the new paragraph 5.1A of the Code of Conduct, a distributor should assess a client’s knowledge of derivatives and characterize the client (other than professional investors for the purpose of paragraph 15 of the Code of Conduct) based on his knowledge of derivatives:-

  • “5.1A Know your client: investor characterization (with effect from 4 June 2011)
    (a) Except where a client is a Professional Investor for the purpose of paragraph 15 of the Code, a licensed or registered person should, as part of the know your client procedures, assess the client’s knowledge of derivatives and characterize the client based on his knowledge of derivatives.

    (b) Where a client without knowledge of derivatives wishes to purchase a derivative product (hereafter refer to as a “transaction” in this paragraph) which is:

    (i) traded on an exchange and the licensed or registered person has not solicited the client or made a recommendation to the client in relation to the proposed transaction, the licensed or registered person should explain the relevant risks associated with the product to the client;

    (ii) not traded on an exchange and the licensed or registered person has not solicited the client or made a recommendation to the client in relation to the proposed transaction, the licensed or registered person should warn the client about the transaction and, having regard to the information about the client of which the licensed or registered person is or should be aware through the exercise of due diligence, particularly the fact that he is a client without knowledge of derivatives, the licensed or registered person should provide appropriate advice to the client as to whether or not the transaction is suitable for the client in all the circumstances. Records of the warning and other communications with the client should be kept. If the transaction is assessed to be unsuitable for the client, the licensed or registered person may only proceed to effect the transaction if to do so would be acting in the best interests of the client in accordance with the general principles of the Code.”


(b) Pre-sale Disclosure of Monetary and Non-monetary Benefit

The New Code of Conduct requires distributors to provide relevant disclosure regarding the benefits they receive from product issuers for distributing their investment products. Under the new paragraph 8.3 of the Code of Conduct:-

    “Information for clients”
    8.3 Pre-sale disclosure of monetary and non-monetary benefits (with effect from 4 June 2011)
    Part A
    Disclosure of monetary benefits
    Where the monetary benefits received are quantifiable
    (a) Specific disclosure
    Explicit remuneration arrangement
    (i) Where a licensed or registered person and/or any of its associates explicitly receives monetary benefits from a product issuer (directly or indirectly) for distributing an investment product, the licensed or registered person should disclose the monetary benefits that are receivable by it and/or any of its associates as a percentage ceiling of the investment amount or the dollar equivalent.
    Trading profit made from a back-to-back transaction
    (ii) Where a licensed or registered person enters into a back-to-back transaction concerning an investment product, the licensed or registered person should disclose to the client the trading profit to be made. The trading profit should be disclosed as a percentage ceiling of the investment amount or the dollar equivalent.

    Notes

    For the avoidance of doubt, the specific disclosure should be made on a transaction basis.

    As a minimum, a licensed or registered person should disclose the monetary benefits that are receivable by it and/or any of its associates or the trading profit in the form of a percentage ceiling of the investment amount rounded up to the nearest whole percentage point or the dollar equivalent. However, having regard to its own circumstances, the licensed or registered person may disclose a specific percentage or the dollar equivalent instead.

    Back-to-back transactions refer to those transactions where a licensed or registered person, after receiving a purchase order from an investor, purchases an investment product from a third party and then sells the same investment product to the investor and no market risk is taken by the licensed or registered person.
    (b) Generic disclosure
    Non-explicit remuneration arrangement
    (i) Where a licensed or registered person does not explicitly receive monetary benefits for distributing an investment product which is issued by it or any of its associates, the licensed or registered person should disclose that it or any of its associates will benefit from the origination and distribution of this product.
    Where the monetary benefits received are not quantifiable:
    (ii) Where the monetary benefits received by a licensed or registered person and/or any of its associates are not quantifiable prior to or at the point of sale, the licensed or registered person should disclose the existence and nature of such monetary benefits.
    Part B
    Disclosure of non-monetary benefits
    (a) Where a licensed or registered person and/or any of its associates receives from a product issuer non-monetary benefits for distributing an investment product, the licensed or registered person should disclose the existence and nature of such non-monetary benefits.”


(c) Disclosure of Sale Related Information

Distributors are required to disclose sales related information to investors (i.e. the capacity in which a distributor is acting, any affiliation with the product issuer, monetary and non-monetary benefits received by distributor and including any discounts of fees and charges) prior to or at the point of sale.

A new paragraph 8.3A added to the Code of Conduct provides:-

    “8.3A   Disclosure of sales related information (with effect from 4 June 2011)
    (a) Where a licensed or registered person distributes an investment product to a client other than a Professional Investor for the purpose of paragraph 15 of the Code, the licensed or registered person should deliver the following information to the client prior to or at the point of sale:
  1. The capacity (principal or agent) in which a licensed or registered person is acting;
  2. Affiliation of the licensed or registered person with the product issuer;
  3. Disclosure of monetary and non-monetary benefits (Please refer to paragraph 8.3 of the Code); and
  4. Terms and conditions in generic terms under which client may receive a discount of fees and charges from a licensed or registered person.
    (b) The disclosure must be made in writing, electronically or otherwise. The licensed or registered person should have adequate measures in place to ensure that the above information is provided to the client prior to or at the point of sale.
    (c) In circumstances where provision of information in written form is not possible before a transaction is concluded, the licensed or registered person should make a verbal disclosure and provide such information in writing to the client as soon as practicable after the conclusion of the transaction.
    (d)The information disclosed in written form should be in Chinese or English according to the language preference of the client.
    Notes
    The licensed or registered person should ensure that the disclosure in writing is prominent, is presented in a clear and concise manner and is easy for average clients to understand.”


(d) Refund by Distributors under the Cooling-Off Period provision

A “cooling-off” period has been introduced to the investment product whereby for a specified time period following their signing of a contract, an investor can change their mind about purchasing the investment product and exercise their right under this mechanism to back out of the purchase and get a refund (including any sales commission), less a reasonable administrative charge.

A new paragraph 13.5 has been added to the Code of Conduct:-

    “13.5 Refund obligation
    Where a cooling-off mechanism is incorporated in an investment product and a client exercises his right under such mechanism to cancel the order, sell the product back to the issuer or its agent, or otherwise unwind the transaction in relation to that product, the licensed or registered person should promptly execute the client’s instruction and pass on to the client the full amount of refund (including the sales commission (refer to Note 1 below) ) received from the product issuer less a reasonable administrative charge (refer to Note 2 below).
    Notes
    1 This includes any sales commission retained by the licensed or registered person in relation to that transaction.

    2 The administrative charge should be disclosed to the client at or prior to point of sale and should not contain any profit margin.”

This “post-sale” cooling period offers an additional layer of protection to the investors. The HKMA has also imposed a “pre-sale” cooling off period which applies to the period between the time of the provision of disclosure documents and the closing of the sale.

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