- key observations from their joint thematic reviews on the sale of investment products that are manufactured and distributed by different entities within the same financial group; and
- expected standards and good practices for financial institutions to manage conflicts of interest.
The circular is focused on the cross-selling activities of conglomerate financial institutions, but is relevant to all intermediaries. The Regulators’ observations in the four review areas, and related expectations, are listed out below.
1. Order execution: Preference over in-house products and insufficient disclosure of related entities’ transactions
The Regulators expect financial institutions to achieve best execution by implementing appropriate control measures to:
- compare in-house and external quotes and disclose to clients where external quotes are unavailable;
- disclose monetary and non-monetary benefits and affiliation with product issuers prior to or at the point of entering into a transaction;
- disclose material interests in a transaction with or for a client and take all reasonable steps to ensure fair treatment to clients;
- regularly review disclosure of information;
- provide an appropriate level of training and guidance to staff on the selection of in-house and external products for clients; and
- perform specific reviews of the effectiveness of the control measures.
2. Product due diligence: Lack of independent and adequate assessment
Financial institutions are expected to understand their in-house products thoroughly before soliciting investment from or making recommendation to clients. An adequate and independent conflict assessment should be conducted and include the following elements:
- potential conflicts must be identified and considered where related entities provide due diligence services;
- consideration of actual or potential conflicts must be based on all relevant factors (e.g. the relationship between product issuers and distributors and benefits generated from the distribution of in-house products);
- conflict assessment should be conducted by the relevant control functions;
- product approval or conflict clearance must be obtained from senior management;
- proper documentation of product due diligence must be maintained.
3. Selling process and discretionary portfolio management: Inadequate disclosure of fee implications of different products; and concentration of investments in in-house products
Financial institutions are expected to consider all relevant information (e.g. charges, mark-ups or fees of different products and clients’ circumstances) before selling or recommending investment products to clients. They should select products which match with the clients’ investment strategies, risk expectations and personal circumstances when managing clients’ portfolios. They should also disclose their material interests in a transaction with or for a client or a relationship which gives rise to actual or potential conflicts of interest, for example:
- they should explain to clients any preference for internally managed strategies, and provide clients with options to exclude certain in-house products;
- they should disclose, in clients’ monthly statements, the percentage split of investment allocation between in-house managed and third-party managed strategies.
4. Management supervision, and controls and monitoring: Defective conflict management
The Regulators expect financial institutions to establish proper policies and procedures to address potential conflicts arising from the distribution of in-house products, review the effectiveness of their implementation and provide regular training and guidance to staff. Examples of good practices are:
- Staff are provided with clear and written guidance about conflicts of interest, including a list of focus areas and scenarios which helps staff identify actual and potential conflicts of interest.
- Conflicts of interest is a standard item in annual risk assessment. Specific check points are specified to ensure effective tracking and assessment of business activities with potential conflicts of interest.
The thematic review is the latest in a series of reviews undertaken by the Regulators into sales practices in the financial services industry. The expectations expressed are not new but for the most part reiterate standards of conduct which have been published in circulars, FAQs and reports on several previous occasions. It therefore speaks volumes that the Regulators have felt it necessary following this latest review to draw shortcomings to the attention of the industry. Intermediaries would be wise to conduct a critical review of their practices and systems to ensure that none of the weaknesses identified by the Regulators apply to their businesses, as vigorous enforcement action can be expected in future.