Suitability

New measures

On 12 December 2016, China Securities Regulatory Commission (CSRC), the regulator of PRC securities market, released Measures on the Suitability Management of Securities and Futures Investors (the Measures), which will come into effect on 1 July 2017. Prior to the issuance of the Measures, there was not a centrally formulated regime at the national level in respect of suitability requirements, as the PRC financial sectors have traditionally been regulated by different regulators, each adopting their own set of rules. The Measures for the first time will provide, at the national level, a unified set of enhanced suitability guidance to all institutions engaged in the selling of securities, funds, futures and derivatives in the domestic market (operating institutions), bringing to an end any opportunity for regulatory arbitrage. The Measures will apply to both retail products and privately offered products. Although the Measures do not directly apply to the offering of offshore products, the requirements may be relevant to foreign managers that, directly or indirectly, provide investment advisory services to domestic investors.

Ordinary investors and professional investors

In line with the professional investor regime in Hong Kong, the Measures divide investors into two categories: “professional investors” and “ordinary investors”. Professional investors include financial institutions, wealth management products issued by financial institutions, social security funds, pension funds, social welfare funds, qualified foreign institution investors (QFIIs), Renminbi QFIIs and other corporate and individuals that meet the prescribed qualification criteria. Investors other than professional investors are ordinary investors. Operating institutions shall ascertain the risk tolerance levels of ordinary investors and further divide ordinary investors into different categories as necessary.

It is worth noting that certain corporate and individual professional investors can opt to be treated as ordinary investors by written notice to the operating institutions. On the other hand, ordinary investors that satisfy certain requirements under the Measures can apply to be treated as professional investors, subject to the operating institution’s consent.

The Measures also introduce a category of “investors with the lowest risk tolerance level”. Selling any products or providing any services to such investors beyond their risk tolerance level shall be strictly prohibited at all times.

Suitability requirements

In addition to categorisation of different investors, operating institutions shall also categorise different financial products and services, having regard to their respective features and levels of risks, and determine which products and services are suitable for each type of investor. Operating institutions shall not solicit ordinary investors for any products or services that are beyond their risk tolerance levels or that do not match their investment objectives; these restrictions do not apply to professional investors.

The Measures provide for a safe harbour for operating institutions to sell to investors (including both professional investors and ordinary investors, but excluding “investors with the lowest risk tolerance level”) products or services beyond their risk tolerance levels, provided that the following procedures have been followed in strict sequence: (i) the operating institution has informed the investor that the product or service is not suitable; (ii) the investor on its own initiative requests for products or services beyond its risk tolerance level; (iii) the operating institution determines that the investor is not an “investor with the lowest risk tolerance level” and provides written risk disclosures to such investor that the product or service is beyond its risk tolerance levels; and (iv) the investor still insists on purchasing the product or obtaining the service.

The operating institution bears the burden of proving that it has satisfied its suitability obligations in the event of a dispute.

Special protections for ordinary investors

Affording an enhanced level of protection towards ordinary investors is one of the primary regulatory focuses as reflected throughout the Measures, with an enhanced level of information rights, risk disclosures, and suitability obligations.

In addition to the Measures, which are issued by the CSRC and thus a ministry-level regulation, the PRC national legislative body is also in the process of revising the PRC Securities Laws, and suitability obligations have been included in the draft revised laws (see Articles 168 and 303 of the draft revised PRC Securities Law). Such provisions, once approved, will afford domestic investors with suitability protections at the level of law.

Second reading of the draft revised PRC Securities Laws

On 24 April 2017, the PRC national legislative body reviewed the draft revised PRC Securities Laws for the second time. Amongst the proposed changes, the following deserve special attention by the asset management industry:

  • To enhance the integrity of the securities market, the draft laws propose to create a standalone chapter for “information disclosure”, which proposes to expand the scope of obligors, increase requisite contents to be disclosed, specify the manner of making a disclosure, and emphasise responsibilities of the directors, the supervisory board and the senior managers of an issuer. In addition to the requirements of truthfulness, accuracy and completeness, the draft laws further propose to require that the disclosures should be concise, clear and easy to understand.
  • The draft laws propose to expand the scope of “insiders” who can get access to inside information for the purpose of determining insider trading, and provide statutory grounds for circumstances giving rise to market manipulation.
  • The draft laws propose to enhance China’s requirement that an investor’s securities trading activities must be carried out in its own real-name accounts and prohibit disguised trading carried out in third-parties’ accounts.
  • The draft laws propose to create a standalone chapter on investor protection, and for the first time introduce suitability obligations on the part of selling institutions at the level of law.

Information disclosure, insider trading and market manipulation have traditionally been and continue to be areas of focus for the CSRC’s enforcement actions. Foreign investors are advised to review their compliance procedures to ensure compliance with PRC laws and regulations.