In December, the HKMA and the SFC submitted reports to the Hong Kong Government providing information and observations of the existing regulatory regime and investor protection framework applicable to the sale to retail investors of Lehman Brothers minibonds and other structured products akin to minibonds. Both reports contain a number of recommendations for measures to restore confidence of investors and strengthen the protection of investors. A brief summary of the recommendations are as follows:
- HKMA recommendations
- Policy - The Government should reaffirm the retention of the present disclosure-based system. Public education campaigns regarding the policy objectives should be periodically undertaken, focusing particularly on the responsibilities of investors, intermediaries and regulators. Regulatory framework should be strengthened to take into account the growth in the volume and complexity of investment products sold to the retail public by authorised institutions and the change in public expectations and risk tolerance by investors.
- Disclosure - "Health-warnings" should be attached to retail structured products with embedded derivatives or to retail derivative products generally. Uniform disclosure formats, such as key fact statements, should be required to be produced in respect of retail investment products. The Government should consider whether there should be restrictions on the use of gifts as a marketing tool to promote financial products to investors. A review of the private placement regime should also be undertaken to ensure that the regime is appropriate in the light of market developments.
- Supervisory architecture - All aspects of securities business conducted by authorised institutions (including registration, standard-setting, supervision, investigation and sanction) should be placed under the HKMA. Coordination between the HKMA and the SFC with the aim of setting broadly consistent standards of conduct should also be strengthened.
- Regulation at point of sale - Authorised institutions which are registered institutions should continue to be permitted to undertake securities business. However, steps need to be undertaken to ensure clearer differentiation between deposit-taking activities and retail securities business. Similar steps should also be undertaken to differentiate between insurance activities and other investment activities. In order to provide further protection for investors, the assessment of a customer's risk profile be separated from the sales process and be carried out by non-sales staff and that the customer be provided with a copy of the risk profile and asked to confirm his agreement that the risk profile is accurate. It should become mandatory to audio-record each assessment process. Regulatory requirements at point of sale should be reviewed with a view to introducing mandatory requirements for the audio-recording of the sales process and ancillary arrangements. Where, as a result of ongoing due diligence, a distributing institution decides to change the risk-rating of a product, the institution should disclose this to customers to whom it recommended and sold the product. In cases of sales of investment products where there is a risk mismatch between the risk rating applied to the product and the customer's risk profile, full and complete documentation should be retained of the reasons why the customers made the investment decision, the sales process should be audio-recorded and endorsement should be sought from supervisory staff within the institution. The HKMA recommends the introduction of mandatory requirements for the imposition of a cooling-off period between the provision of disclosure documents and the closing of sale. Subject to certain safeguards, consideration should be given to allow waivers of such cooling-off period. A mystery shopper programme be instituted periodically by the HKMA to test sales processes and a pilot programme of customer surveys be commissioned by the HKMA to gauge whether such surveys can provide information useful for the examination of specific issues in the context of the longer-term customer relationship. The HKMA will put greater focus on the remuneration structures for staff engaged in authorised institutions' securities business in the HKMA's on-site examinations and off-site surveillance.
- Dispute resolution - The Government should consider the establishment of a dispute resolution mechanism for the financial industry in Hong Kong and the need for a financial ombudsman to order compensation.
- SFC recommendations
In addition to recommendations similar to the ones listed in (2), (4) and (5) above, the SFC also proposed to the Government to consider the following:
- Regulatory supervision of documentation - To maintain a regulatory philosophy of disclosure coupled with conduct regulation of intermediaries rather than merit regulation. Through investor education, to advise investors what is meant by SFC authorisation of a product.
- SFC authorisation of documentation - To set one overall disclosure standard for all offering documents relating to retail investment products which are enforceable against persons responsible for offering such documents. The SFC recommends to consider whether Hong Kong should retain two public offering regimes for investment products and whether the existing exemptions from the requirement for SFC authorisation of offering documents for investments are currently too broad.
- On going disclosure obligations for issues of products - To introduce new requirements in the SFO for issuers of investment products to provide relevant information (such as price information and changes in circumstances that may have a significant effect on the value of the investment) for investors. Intermediaries should take appropriate steps to ensure that such information is brought to attention of investors. The SFC also recommends that the its website becomes the repository of information about unlisted investment products that have been authorised by the SFC.
- Marketing materials - SFC to revise its published guidance on marketing materials to establish general principles, supplemented where necessary by specific requirements, that assist the market to develop materials that are correct, properly balanced and not misleading.
- Definition of professional investors - SFC to consult the market on whether it is appropriate to raise the minimum asset portfolio requirement under the PI Rules and to clarify and tighten the assessment criteria under the Code of Conduct.
- Disclosure of commissions, fees and other benefits - SFC to review requirements for comprehensive disclosure to clients at the pre-sale stage of commissions, fees and other benefits the intermediary receives from the sale of the products that it recommends and is offering to clients.
- Assess suitability of investment products for individual investors - Intermediaries should conduct a self examination of their controls and procedures to ensure that these provide senior management with sufficient assurance they meet their general obligations under the Code of Conduct. They should ensure staff receive adequate training and products should only be sold by staff that have demonstrated a sufficient understanding of the particular product. Their staff should document and provide a copy to each client of the rationale underlying the recommendations/solicitations made to the client.
- Dispute resolution - the Code of Conduct be amended to require that client agreements specify a right for clients to have their grievances resolved by a dispute resolution procedure.
- Investor education council - To establish an investor education council which will co-ordinate and deliver extensive investor education programme across the financial services sector.
- Enforcement powers - To amend the SFO to allow certain powers to be delegated by the SFC Board and to extend the grounds for application for certain orders. In addition, the SFC seeks to be granted the power to impose a compensation order as a disciplinary sanction.