Guidelines on Online Distribution and Advisory Platforms (the Guidelines) and Paragraph 5.5 of the Code of Conduct
[Guidance provided in these FAQs may also be relevant to offline transactions.]
(Q33 and Q34 were updated on 22 March 2019) (Q35 to Q38 were updated on 13 June 2019)
(Q39 was updated on 23 December 2020)
Do online platforms that do not have any operations in Hong Kong need to be licensed by the SFC in order to sell investment products to Hong Kong investors?
Generally speaking, companies carrying on a business in regulated activities in Hong Kong would have to be licensed by or registered with the SFC1 . The type of licence required to operate an online platform would depend on the regulated activity to be performed (eg, a Type 1 licence would likely be required for a fund distribution platform). The fact that an offshore operator does not have operations in Hong Kong would suggest that it does not carry on a business in regulated activities in Hong Kong. However, licensing requirements may still be triggered2 if: (i) the operator holds itself out as carrying on such a business in Hong Kong; or (ii) its services that amount to carrying on such a business are actively marketed to the public in Hong Kong, whether by itself or by other entities on its behalf in Hong Kong or from elsewhere.
What types of platforms do the Guidelines apply to? Do websites that only showcase products and research reports fall within the scope of the Guidelines? How about order management systems through which clients send their order execution messages to the intermediary, who then in turn confirm the execution back to the client via the same messaging portal?
The Guidelines are applicable to all SFC-licensed and registered persons when conducting regulated activities in providing order execution, distribution and advisory3 services in respect of investment products via online platforms. Thus, the Guidelines will not apply to, for example, websites that showcase products only or websites that provide advice on asset allocation among general asset classes without providing advice concerning specific investment products, and without providing any order execution, distribution or advisory services.
In relation to order management systems that merely provide a means of communication between an intermediary and a client, intermediaries should note that if there is any interactive communication between the intermediary and its client through such order management systems, it may trigger the Suitability Requirement, depending on whether the communication involves a solicitation or recommendation. Intermediaries should refer to guidance issued by the SFC in this connection4. Where such order management systems are accessible by clients via its online platform and provide a means for clients to place orders, the Platform Operator should note the requirements in the Guidelines that would generally apply (such as system reliability). Other regulatory requirements applicable to the use of such systems and order handling (eg, the Code of Conduct5, various FAQs, and the Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the SFC) should also be noted.
Where an intermediary operates different websites, it is possible that some of them on their own may not amount to conducting regulated activities, such as a website which only provides information. However, some websites may be linked to a social network where users can discuss investment ideas with an investment adviser and a separate website which provides trade execution services. The SFC will take into account activities targeting Hong Kong investors conducted by the intermediary via all channels in their totality in considering the intermediary’s compliance with the Guidelines.
B. Core Principles for the operation of online platforms
Can Platform Operators make available investment products that are not authorized by the SFC (such as ETFs traded on an overseas exchange) on their online platforms?
Part IV of the SFO restricts offers of investments to the Hong Kong public. Platform Operators should ensure that their online platforms are properly designed and have appropriate access rights and controls to ensure compliance with Part IV of the SFO. Whether the provision of information to a client about ETFs traded on an overseas exchange would amount to a breach of Part IV of the SFO would depend on the facts and circumstances of each case. The key issue would be whether such information would amount to an advertisement, invitation or document that is or contains an invitation to the public to invest in those ETFs.
For example, in the case of a Platform Operator which provides investment advisory services or discretionary portfolio management services to its clients, it should have already conducted proper know-your-client (KYC) procedures to obtain sufficient information on its clients at the time of on-boarding. If, after taking into account his/her personal circumstances, the platform then makes a recommendation to that client with whom it has a one-to-one advisory relationship to invest in particular ETFs traded on an overseas exchange or effects transactions in such ETFs for that client, this is unlikely to amount to an invitation to the public, which, if not authorized, is prohibited under Part IV of the SFO.
In the case of a Platform Operator which provides execution services for overseas ETFs, if the platform does not set out any information about these ETFs (save for information on the exchanges for which it provides execution services) and its client would only be able to access factual information about such ETFs after keying in the relevant stock code himself/herself, this is also unlikely to be captured under Part IV of the SFO. Platform Operators are encouraged to seek professional advice.
For online platforms that only target non-retail investors, can the platform rely solely on the client’s self-declaration confirming that he or she is not a Hong Kong retail investor to fulfil the requirement to restrict offers of investments under Part IV of the SFO?
Platform Operators should ensure that their online platforms are properly designed and have appropriate access rights and controls to ensure compliance with Part IV of the SFO. Intermediaries are required under the Securities and Futures (Professional Investor) Rules to use methods which are appropriate to satisfy themselves that an investor meets the relevant assets or portfolio threshold to qualify as a professional investor, or to obtain certain prescribed evidential documents showing that the investor qualifies as a professional investor. Platform Operators should keep proper records of their assessment process or the prescribed evidential documents obtained so as to demonstrate that they have exercised professional judgment and have reached a reasonable conclusion that their clients meet the relevant thresholds.
Is a Platform Operator expected to ensure reliability and accuracy of all data posted on their platform, including third-party data such as each item in an automatic news feed from the press or third-party data used in generating investment advice?
Under the Guidelines, a Platform Operator is expected to act with due skill, care and diligence when posting information and materials on its online platform. This would include acting with due skill, care and diligence in the selection, appointment and ongoing monitoring of any third-party service provider to enable it to be reasonably satisfied that the information provided by the service provider is accurate and reliable.
For example, while the SFC does not generally expect Platform Operators to monitor the accuracy of each and every news feed item or stock price update, if Platform Operators become aware of incidents which may suggest that the third party may no longer be competent in providing its services, they should consider whether to continue to engage its services.
Can Platform Operators post commentaries made by a renowned investor, or details of the portfolios of investment products in which the renowned investor has invested, on their online platforms?
Under the Guidelines, a Platform Operator is expected to act with due skill, care and diligence when posting information and materials on its online platform. For example, Platform Operators should give due consideration to the independence, reputation and relevant expertise of the renowned investor the commentaries of which are posted on their online platforms and should be satisfied that the renowned investor has reasonable bases for his/her commentaries.
Further and in particular, Platform Operators should exercise caution when posting any such commentaries or details of portfolios of investment products where unlicensed persons are involved. This is because they are not subject to the SFC’s various regulatory requirements, including conduct requirements requiring licensed and registered persons to act with due, skill, care and diligence, and to ensure that any representations made and information provided are accurate and not misleading.
The Guidelines require a Platform Operator to provide clients with material information as soon as reasonably practicable to enable clients to appraise the position of their investments.
What kind of material information is a Platform Operator expected to provide? If an investment product held by the client is no longer available for sale on the platform, what is the Platform Operator’s obligation in disclosing up-to-date information about this investment product?
Platform Operators are expected to provide clients with material information as soon as reasonably practicable. This includes information provided by issuers concerning material changes to, or material events concerning, an investment product (eg, suspensions of the redemption of funds, any proposed merger or termination of funds).
Generally, where Platform Operators (which act as distributors) or their nominees hold an investment product on behalf of their clients, they are expected to disseminate or procure the dissemination of notices and other communications prepared/ issued by the issuer of the investment product to their clients on a timely basis upon receipt of the notices from the issuer. These could be sent to clients in any form as chosen by Platform Operators or their nominees.
A Platform Operator is expected to post on its online platform updated information about investment products which are available for sale on the platform. Where an investment product held by its clients is no longer available for sale on the platform, the Platform Operator should still disseminate or procure the dissemination of notices and other communications prepared or issued by the product issuer to its clients if the Platform Operator or its nominee holds the investment product on behalf of its clients.
The Guidelines require a Platform Operator to make available information on the methodology adopted for assessing and assigning ratings to investment products and categorising clients on the online platform. Is a general description adequate in meeting this requirement?
The purpose of this disclosure requirement is to enable clients to form a general understanding of the methodology adopted for risk ratings provided by online platforms. The SFC does not expect platforms to go into the technical details of the methodologies (for example, detailed disclosure of the weightings for the factors that a Platform Operator takes into account is not required). The focus is to enable clients to understand and assess how they should incorporate risk ratings into their investment decisions. Information should be communicated in an easily comprehensible manner by using plain language to make the disclosure easy for investors to read and understand.
The Guidelines require a Platform Operator to inform clients about the scope and limitation of services and investment products that are provided through and on its online platform. In this regard, can the SFC provide some guidance or examples on what kind of information is expected to be communicated?
For example, Platform Operators could inform clients of how the online platform deals with cancellation of orders and services, and whether the availability of investment products is limited to those issued by related companies. For robo-advisers, where a robo-adviser provides goals-based advice such as planning for education of children, it should inform clients of this and should not describe its services as providing comprehensive financial planning.
Platform Operators may provide more information as they deem appropriate, in particular if such information is considered relevant material information in dealings with clients.
What is the SFC’s expectation regarding a “suitably-qualified person” that is expected to test, review, and ensure the reasonableness of advice provided on a robo-advice platform?
A robo-adviser should exercise its professional judgment about who would be an appropriate person with the experience and competency to carry out these duties. For example, the third-party service provider which designed the algorithm may work with the investment manager or adviser and the compliance officer to ensure the algorithm is generating appropriate advice for platform users.
Are trades executed by robo-advisers, as a result of automatic rebalancing of a portfolio, a solicitation or recommendation?
Yes, auto-rebalancing (for example, for the purpose of controlling the risk weighting of existing products within a portfolio, or making changes to the portfolio by adding or removing products) would generally be regarded as a recommendation and trigger the Suitability Requirement, as the client would be buying or selling products in the portfolio on the advice or recommendation of the robo-adviser. If the purpose of rebalancing would be to maintain the target asset allocation of a predefined model portfolio previously agreed with a client, robo-advisers can discharge their suitability obligations by ensuring that the rebalancing is conducted in accordance with the predefined portfolio.
Does the Platform Operator need to ensure the suitability of a client’s portfolio if the client chooses to opt-out of automatic portfolio rebalancing?
The Platform Operator should explain to its clients the purpose of rebalancing. If a robo-adviser offers clients the flexibility to opt-out of auto-rebalancing, it should inform clients of the potential risks and consequences of opting out of the rebalancing service (for example, their portfolio may no longer maintain the target asset allocation over time). It should also warn clients that the original portfolio that they may invest into or have invested into according to the robo-adviser’s recommendation could, as a result of the opt-out, become unsuitable for them and that they require a different service to be provided. If a client insists on opting out, the client should be directed to acknowledge and confirm a change in the scope and terms of services to be provided by the online platform going forward. Although the robo-adviser may no longer have an advisory relationship with the client as a result, it should still comply with all other applicable requirements in the Guidelines. This includes the requirement to ensure suitability in the sale of any complex product online.
Will a robo-adviser be in breach of Part IV of the SFO if it includes overseas ETFs in its recommended model portfolios?
Whether the inclusion of overseas ETFs in model portfolios would be in breach of Part IV of the SFO depends on the facts and circumstances of each case, and in particular, whether there was an invitation to the public to acquire an interest in the ETFs. For example, some robo-advisers may choose to describe their scope of services to include the distribution of investment products which are overseas ETFs (without specifying or disclosing the particulars of the investment products in the model portfolio which is generated). Others may generate a tailor-made recommended portfolio which includes overseas ETFs for a particular client with whom they have a one-to-one advisory relationship only after taking into account that client’s personal circumstances. These are unlikely to be in breach of Part IV of the SFO.
Robo-advisers should ensure their online platforms are properly designed in compliance with the applicable laws and regulations. Robo-advisers are encouraged to seek professional advice.
In respect of the requirement for robo-advisers to provide information to clients including a description on how underlying algorithms operate and any limitations of the algorithm, does a broad, high level disclosure satisfy this requirement?
It is important for clients to understand how investment advice is generated and how algorithms are used to manage their accounts. Information provided to clients should include the limitations of the robo-adviser’s services and how and when the algorithm might rebalance a client’s portfolio. The SFC does not expect platforms to go into the technical details of the algorithms. The focus of the requirement is that clients are provided with information which enables them to assess whether to use the services of the robo-adviser. Disclosures must be clear and easy to read. Overly technical terms should be avoided.
D. Triggering of Suitability Requirement
Can the SFC give some examples of when the context (such as manner of presentation) and content of materials posted on an online platform would or would not trigger the Suitability Requirement?
The context (such as the manner of presentation) and content of product-specific materials posted on an online platform coupled with the design and overall impression created by the platform content would determine whether the Suitability Requirement is triggered. This is the case irrespective of the type of product being sold.
As set out in the Consultation Conclusions on the Proposed Guidelines on Online Distribution and Advisory Platforms6, the following are non-exhaustive lists of examples of when the posting of materials would or would not trigger the Suitability Requirement:
Examples of when the Suitability Requirement is NOT triggered:
Provision of a direct facility to input stock codes to place orders for exchange-traded products for secondary market trading on the relevant exchange.
Posting of lists of, and provision of access to, investment products and posting of factual information such as corporate information (eg, announcements, circulars or annual reports) issued by listed issuers or the provision of a link to such information on the SEHK7’s website8 or other factual information (eg, offering documents, notices to investors, annual reports and fact sheets).
Posting of lists of investment products that are selected using objective criteria (eg, performance data, sales figures, research data).
Posting of advertisements of fee discounts not tied to any specific investment product (eg, lower subscription fees during a client’s birthday month, time-limited reduced rates or loyalty discounts to reduce transaction fees in general).
Provision of objective filters for self-directed research on investment products (eg, geographical location, underlying assets, one-year, three-year, five-year performance data or performance data since launch, risk categories and third party or in-house risk ratings).
Posting of non-product-specific information such as market news or updates, industry and sector trends, and education materials.
The simple flashing of a “new” icon next to newly published research reports (which may contain views on buy, hold or sell with target prices) or newly available investment products.
Posting of model portfolios that are constructed using objective criteria (eg, research data, performance data, asset allocation strategies/models) which are not linked to or generated based on information provided by the client.
Posting statistics or trends in customer activities involving a particular product that are factual and based on objective criteria and do not put pressure on a client to proceed with a transaction (for example, setting out a list of investment products with a description that “Other clients who bought product A also looked at these products”.)
Posting of educational materials that are product-specific as long as such materials do not include (standing alone or in combination with other communications) a recommendation of the specific investment product.
Examples of when the Suitability Requirement IS triggered:
Posting of advertisements which include product-specific incentives (eg, cash rebates, fee discounts) for any transactions in a specific investment product9.
Posting of product-specific research reports on an investment product which include words such as “Don’t Miss Out!” or “Act Now!”.
Persistent pop-ups or flashing in connection with a specific investment product.
Presenting a specific list of investment products with an accompanying statement such as “product of risk rating X or below may suit you or match your risk tolerance level” or “these products may suit you or match your risk tolerance level” to clients immediately after the online platform conducts a risk profiling of clients.
Upon a client’s completion of the know-your-client process or provision of information through a client profiling tool or upon a client providing updates to his or her information, generating a specific model portfolio with a list of investment products or generating a list of selected investment products which may be perceived to be based on a consideration of the information provided by the client.
Presenting a model portfolio that allocates a percentage of the portfolio to a class of products (eg, bonds) but there is only one product in that class of product offered by the platform.
Showing the performance of a model portfolio offered by the platform against the performance of the client’s current portfolio held with the platform without the client requesting for such comparison.
The above examples are non-exhaustive and for illustration only. Platform Operators should consider their own circumstances having regard to guidance10 published by the SFC (which may be updated from time to time).
Can the SFC provide examples or guidance on when the design and overall impression created by the content of an online platform would trigger the Suitability Requirement?
The posting of factual, fair and balanced product-specific materials would not in itself amount to a solicitation or recommendation and will not trigger the Suitability Requirement in the absence of other facts and circumstances that may reasonably be expected to influence investors.
In determining whether the posting of materials would trigger the Suitability Requirement, the assessment should take into account the content and context of these materials coupled with the design and overall impression created by the platform content.
The SFC has provided a list of examples of when the Suitability Requirement is and is not triggered, as set out in the answer to the question above. For example, the posting of research reports (which may contain views on buy, hold or sell with target prices) would not trigger the Suitability Requirement provided that the research reports are factual, fair and balanced.
On factual, fair and balanced materials, we have provided the example that the posting of lists of investment products (ie, such lists are not the full list of investment products available on the online platform but are lists within the full list) selected using objective criteria would not trigger the Suitability Requirement. In this connection, Platform Operators should have a reasonable basis for coming up with the selected lists of products and the objective criteria used should also be set out or made available.
In other words, to trigger the Suitability Requirement, the SFC would expect additional factors to be present which would induce a client to enter into a transaction or that would put pressure on a client to proceed with a transaction, whether through the context (such as the manner of presentation), or the content of the materials. For example, the posting of advertisements with product-specific incentives (eg, cash rebates, fee discounts) or product-specific research reports with words such as “Don’t Miss Out!” or “Act Now!” would trigger the Suitability Requirement. It may also be easier for pop-up messages and flashing icons to give the impression of making recommendations or solicitations which would trigger the Suitability Requirement. For example, persistent pop-ups or flashing in connection with a specific investment product would trigger the Suitability Requirement.
Some online platforms may involve human interaction (eg, through hotlines or live chats) to assist clients with their enquiries. Whether the Suitability Requirement is triggered would depend on whether the human interaction involves a solicitation or recommendation which requires an analysis of the content and context of each interactive communication. Platform Operators should refer to guidance issued by the SFC in this connection11.
E. Discharging the Suitability Requirement
How can the Suitability Requirement be discharged on online platforms?
conducting KYC13 processes to obtain information on the personal circumstances of the client; and
matching the risk return profile of investment products with the personal circumstances of a client to ensure suitability (mainly through taking into account the client’s investment objectives; investment knowledge and experience; risk tolerance; assessing concentration; and considering the client’s investment horizon and financial situation such as net worth and immediate liquidity needs).
Platform Operators can make reference to the policies and procedures, systems and controls that they have already implemented and are currently utilizing in discharging suitability obligations in the offline context when designing the logic behind their online platforms. For example, clients can be asked the same questions for KYC purposes, in ascertaining whether a client’s portfolio has exceeded any concentration threshold, or in determining whether a client has immediate liquidity needs.
Can a Platform Operator consider non-traditional factors such as behavioural economics (eg, big data) in addition to traditional factors such as credit scores and wealth to profile a client in conducting suitability assessments?
For the purpose of conducting suitability assessments, in addition to KYC information about a client's financial situation, investment experience and investment objectives, Platform Operators should collect from each client information that includes the client’s investment knowledge, investment horizon, risk tolerance (including risk of loss of capital) and capacity to make regular contributions and meet extra collateral requirements, where appropriate. The SFC does not limit the factors to be considered or the data (including big data from customer behaviour) to be used in client profiling for the purpose of the suitability assessment. However, a Platform Operator should be reasonably satisfied that a proper assessment is made of both clients and products in order to provide recommendations which are reasonably suitable for its clients.
Can a Platform Operator rely on information provided by a client during the KYC process in conducting a suitability assessment?
Where a Platform Operator has used reasonable efforts to obtain information from clients, the Platform Operator may rely on the information provided by clients in conducting suitability assessments unless the information obtained is inconsistent with the client’s information held with the Platform Operator.
If a client’s answers are inconsistent, the Platform Operator should alert the client and seek to reconcile the inconsistencies before performing the suitability assessment. Platform Operators could implement control procedures to direct clients to the inconsistent information and provide the opportunity for them to change their previous answers and provide the most up-to-date and accurate information.
If incomplete information is provided by a client, the Platform Operator should alert the client and seek clarification from the client before performing the suitability assessment. If disclosure by the client is limited and as a result, the Platform Operator is unable to make that assessment properly, the Platform Operator should, as a minimum, explain to the client the inherent limitations of the recommendations made as a result of the lack of information. Furthermore, the Platform Operator should explain to the client the assumptions, if any, made in relation to such recommendations.
Where a client refuses to disclose his/her financial position, the Platform Operator should only take into account the client’s investable assets under its management when conducting the suitability assessment and avoid making assumptions based on incomplete information or speculation. The less information about the client that the Platform Operator has, the more conservative the suitability assessment should be.
Platform Operators should refer to the FAQs on Compliance with Suitability Obligations by Licensed or Registered Persons.
Is the standard to discharge suitability obligations the same irrespective of whether a product is of low risk or is non-complex?
Once the Suitability Requirement is triggered, the standard for discharging suitability obligations is the same.
However, a proportionate approach to discharging suitability obligations may be adopted, having regard to the riskiness and complexity of a product or transaction. In the case of a complex but low risk product, it should not be difficult for a Platform Operator to match the risk profile of the product and a client’s risk tolerance level which is one of the major factors to be considered when performing a suitability assessment. For a high risk and complex product, a more prudent approach to assessing suitability should be adopted, particularly in assessing concentration.
How can concentration risk be assessed in an online environment? Can the SFC provide guidance on how a Platform Operator should conduct concentration risk assessment?
In the context of online platforms, it is expected that an online platform should have in place appropriate tools for assessing a client’s concentration risk based on the information about the client obtained through the Platform Operator’s KYC process, which should be updated from time to time where appropriate, and any investment portfolio held with the platform.
In conducting the concentration risk assessment, Platform Operators could, having regard to the type of services, nature of products and clients’ risk profiles, set concentration thresholds in respect of the maximum proportion of a client’s net worth and/or investment portfolio that may be invested in high risk products.
Platform Operators should exercise due skill, care and diligence in setting any thresholds and should be prepared to justify any threshold set.
In performing the concentration risk assessment, a Platform Operator should base its assessment on the information about a client obtained through its KYC process and any investment portfolio held with the online platform.
Can a Platform Operator rely on a client’s self-declaration on the proportion of high risk products in his/her net worth and/or investment portfolio when conducting the concentration risk assessment?
If an online platform is designed such that clients can declare the proportion of high risk products in his/her net worth and/or investment portfolio or that the proportion is less than a specific percentage (eg, by way of drop down options for clients to choose), Platform Operators are reminded of their obligation to check for inconsistencies between the information in the self-declaration and the information it has about the client and should reconcile the inconsistencies if there are any.
Can Platform Operators adopt a portfolio-based approach to ensure suitability?
For example, can a high risk investment product be suitable for a person with a medium risk profile?
As set out in the Frequently Asked Questions on Compliance with Suitability Obligations by Licensed or Registered Persons14, Platform Operators should, as part of the suitability assessment, consider the overall effect of their recommended product on their clients’ portfolios. For example, for a client with low or medium risk profile, a proportion of high risk products in the portfolio may not be unsuitable so long as this is commensurate with the risk return profile of the portfolio and the Platform Operator is able to satisfy itself that any investment products recommended are likely to meet the investment objectives and other personal circumstances of the client.
When the Suitability Requirement is triggered (for example, by prior conversations between a Platform Operator’s staff and a client on trade ideas involving a specific product), can a Platform Operator conduct post-trade suitability checks (ie, perform the suitability assessment after executing a trade)?
No. The Code of Conduct15 requires that the Platform Operator should, when making a recommendation or solicitation, ensure the suitability of the recommendation or solicitation for that client is reasonable in all the circumstances. A Platform Operator should ensure the investment product is suitable for the client before making the solicitation or recommendation, or at the latest, before executing the order.
Can an online platform proceed to execute an order which has been assessed to be unsuitable for a client?
Where the Platform Operator, being under the obligation to ensure suitability, has assessed the transaction to be unsuitable for the client but the client wishes to proceed with the transaction despite this, the Platform Operator should not proceed to effect the transaction.
How can a Platform Operator comply with the documentation standards that require intermediaries to maintain records documenting the rationale underlying investment recommendations made to a client?
A Platform Operator should keep proper audit trails of activities and transactions conducted on its online platform, including audit trails and records relating to all suitability assessments and the underlying logic for recommending investment products. Platform Operators should comply with the record keeping requirements set out in paragraph 2.7 of the Guidelines.
F. Sale of complex products on an unsolicited basis
The non-exhaustive list of non-complex products includes shares, ETFs, and REITs traded on the Stock Exchange of Hong Kong. For shares, ETFs, and REITs traded on overseas exchanges, can they be treated as non-complex or are these by default complex products?
For overseas exchange-traded products such as shares, ETFs and REITs, many of them could well be complex. It is therefore the Platform Operator’s responsibility to determine whether such products to be sold on its online platform are non-complex or complex having regard to the factors set out in paragraph 6.1 of the Guidelines and the non-exhaustive list of examples of non-complex and complex products posted on the SFC’s website as guidance (which may be updated from time to time and is accessible via this link).
In general, a Platform Operator may treat an exchange-traded product as non-complex if it is of the same type as a non-complex product listed as an example and is traded on an exchange in a specified jurisdiction. The list of specified jurisdictions for exchange-traded products is posted on the SFC’s website, which may be updated from time to time and is accessible via this link.
Accordingly, a Platform Operator may, for example, generally treat shares or physical ETFs traded on an exchange in the US as non-complex.
Platform Operators should determine whether a product may be treated as non-complex or complex with due skill, care and diligence and should exercise extra caution where the product is traded on an overseas exchange which is not in a specified jurisdiction.
For funds not authorized by the SFC, can Platform Operators treat them as non-complex?
Funds not authorized by the SFC could well be complex. It is therefore the Platform Operator’s responsibility to determine whether such fund to be sold on its online platform is non-complex or complex having regard to the factors set out in paragraph 6.1 of the Guidelines and the non-exhaustive list of examples of non-complex and complex products posted on the SFC’s website (which may be updated from time to time and is accessible via this link).
A derivative fund, irrespective of whether it has obtained the SFC’s authorization, is complex.
In general, a Platform Operator may treat a non-derivative unauthorized public fund16 as non-complex if it is authorized or approved in a specified jurisdiction for public offering. The list of specified jurisdictions for non-exchange-traded unauthorized funds is posted on the SFC’s website, which may be updated from time to time and is accessible via this link.
The current list consists of the jurisdictions in which recognized jurisdiction schemes17 are regulated and jurisdictions with which a mutual recognition of funds arrangement with the SFC is in place.
For example, a plain vanilla Undertakings for Collective Investment in Transferable Securities (UCITS) that is not SFC-authorized but is authorized or approved for offering to retail investors in Luxembourg or a non-derivative equity fund authorized or approved for offering to retail investors in Ireland would likely be non-complex.
Platform Operators should determine whether a fund may be treated as non-complex or complex with due skill, care and diligence and should exercise extra caution where the fund is authorized or approved in a jurisdiction which is not a specified jurisdiction.
It is expected that licensed and registered persons should maintain records documenting the rationale underlying investment recommendations made to the client. How does this requirement apply to the sale of complex products on online platforms on an unsolicited basis?
As set out in the Frequently Asked Questions on Compliance with Suitability Obligations by Licensed or Registered Persons, licensed or registered persons should maintain records documenting the rationale underlying investment recommendations made to the client and provide a copy of the rationale for the recommendations to the client upon his or her request. In the case of a transaction in a complex product on online platforms on an unsolicited basis (ie, the Platform Operator has not solicited or recommended a transaction in the complex product to a client), the requirement to document the rationale underlying investment recommendations would not apply as there would not have been any recommendations involved.
Notwithstanding the above, Platform Operators should keep proper audit trails and records relating to the suitability assessment involving the complex product.
Paragraph 3.4 of the Code of Conduct requires that a licensed or registered person, when providing advice to a client, should act diligently and carefully in providing the advice and ensure that its advice and recommendations are based on thorough analysis and take into account available alternatives.
If a client wishes to purchase a complex product available on an online platform on an unsolicited basis, is the intermediary required to perform a thorough analysis and consider available alternatives?
Paragraph 3.4 of the Code of Conduct applies only when a Platform Operator provides advice to a client. Hence, this provision would not apply to unsolicited sales of complex products on online platforms.
Are intermediaries required to perform a suitability assessment for each transaction made by a client even if it is a repeat purchase of the same or similar complex products?
It should be noted that while an investment product may have been suitable previously it may no longer be suitable due to changes in a client’s personal circumstances or market conditions. Further, depending on the risks of the complex product, repeat purchases may increase the concentration of risk in a client’s investment portfolio. It is thus necessary for Platform Operators to ensure suitability even in the case of repeat purchases. However, a Platform Operator is free to design the steps it could take to discharge the suitability obligations for repeat purchases (for example, the steps could be different from those for a first-time purchase) provided that it can still be reasonably satisfied that a repeat purchase is suitable for a client having regard to the personal circumstances of the client.
Does the suitability clause in client agreements apply to unsolicited sales in complex products on online platforms?
The suitability clause that is required to be included in client agreements pursuant to paragraph 6.2(i) of the Code of Conduct is applicable where an intermediary “solicits the sale of or recommends any financial product to” a client. The clause would therefore not apply to unsolicited sales of complex products on online platforms.
In determining whether an SFC-authorized fund is a complex or non-complex product, are Platform Operators required to consider the detailed underlying investments of the fund?
For the purpose of determining whether an SFC-authorized fund is a complex or non-complex product, Platform Operators are only expected to ascertain whether the fund is a derivative fund or a non-derivative fund.
The SFC has already specified that non-derivative funds authorized by the SFC under the UT Code are considered to be non-complex products in its list of non-complex products. A non-derivative fund is defined as one with a net derivative exposure of up to 50% of its NAV under the UT Code18 effective on 1 January 2019 (subject to transition arrangements ending on 31 December 2019)19.
For funds not authorized by the SFC, could the SFC provide more guidance on when they are considered to be complex products and when they are not?
The determination of whether a product is a complex product or a non-complex product is required when a client purchases a product without a solicitation or recommendation. As unauthorized funds should not be publicly offered, a solicitation or recommendation is likely involved (for example, during interactive communications as part of the offline sales process). In such case, the suitability requirement under paragraph 5.2 of the Code of Conduct20 would have to be complied with regardless of whether the unauthorized fund is a complex product or a non-complex product.
As explained in Question 28 of these FAQs, Platform Operators should have regard to the factors set out in paragraph 6.1 and comply with paragraph 6.2 of the Guidelines in determining whether an unauthorized fund to be sold on its platform is a complex product or not. The categorisation of products as complex or non-complex focuses on whether the terms, features and risks of a product are too complex for a retail investor to understand. In general, for a product to be treated as “non-complex”, it should be adequately transparent, liquid and capable of being easily understood by retail investors.
One of the assessment criteria for complex products is whether the product is a derivative product. An unauthorised fund would be considered to be a complex product if it is a derivative fund. In determining whether an unauthorised fund which may invest in derivatives is a derivative fund, Platform Operators should consider whether the purpose and use of derivatives by the unauthorised fund is comparable to the SFC’s regime under the UT Code effective on 1 January 2019 (subject to transition arrangements ending on 31 December 2019)21.
If an unauthorized fund is considered to be a non-derivative fund, Platform Operators should further ascertain whether the unauthorized fund is authorized or approved for offering to retail investors by an overseas regulator (overseas public fund) and, if so, whether the overseas public fund (listed or unlisted) is regulated in or traded on an exchange in a specified jurisdiction.
In general, a Platform Operator may treat a non-derivative overseas public fund as non-complex if it is regulated in or traded on an exchange in a specified jurisdiction. However, Platform Operators should exercise extra caution where the overseas public fund is regulated in or traded on an exchange in a jurisdiction which is not a specified jurisdiction.
It would be less likely for non-public funds22 (even non-derivative ones) to be considered non-complex, having regard to the factors set out in paragraph 6.1 of the Guidelines, which include availability of information about the fund, liquidity in the secondary market etc.
In determining whether an unauthorised fund is a complex or non-complex product, Platform Operators are expected to consider, among others, the structure and strategy of the fund and the nature of underlying investments with reference to the product disclosure documents. However, they are not expected to perform detailed calculation of the fund’s allocation in each underlying investment.
For reference, a flowchart illustrating the determination of whether an unauthorized fund is a complex product or not can be found on the SFC website at www.sfc.hk under the section “Rules & standards – The Suitability Requirement – Non-complex and complex products”.
If an intermediary (a) solicits the sale of or recommends a complex product; or (b) provides discretionary account services (which involves the making as well as execution of recommendation on a complex product) to a client, does it need to comply with the requirements applicable to complex products under paragraph 5.5 of the Code of Conduct?
If an intermediary solicits the sale of or recommends a financial product or provides discretionary account services to a client, it should comply with paragraph 5.2 of the Code of Conduct and ensure that the product is suitable for the client regardless of whether it is complex or non-complex. In this case, there is no further need for the intermediary to comply with paragraph 5.5 of the Code of Conduct. For the avoidance of doubt, intermediaries should comply with all applicable regulatory requirements, including the FAQs on Compliance with Suitability Obligations by Licensed or Registered Persons23, and provide all relevant material information to clients when discharging their suitability obligations.
If an intermediary executes a transaction in a complex product for a client without making any solicitation or recommendation in respect of the transaction (i.e. the client purchases the complex product on an unsolicited basis), then the intermediary is required to comply with paragraph 5.5 of the Code of Conduct.
If an intermediary provides a loan to its clients to buy a non-complex product (e.g. shares listed and traded on the Stock Exchange of Hong Kong Limited (SEHK)), should the intermediary treat the product as a complex product and comply with Chapter 6 of the Guidelines and paragraph 5.5 of the Code of Conduct (the Requirements) when providing the service to its clients?
Intermediaries should have regard to the factors set out in paragraph 6.1 of the Guidelines (and paragraph 5.5 of the Code of Conduct) and comply with paragraph 6.2 of the Guidelines in determining whether a product is a complex product or non-complex product. This would include having regard to the non-exhaustive list of examples of “non-complex” and “complex” products posted on the SFC’s website.
As the provision of a loan to a client to facilitate him or her to buy a non-complex product or a leveraged transaction on a non-complex product (e.g. shares listed and traded on the SEHK) does not alter the terms, features and risks of the underlying investment product, the provision of such services would not convert a non-complex product into a complex product. Hence, intermediaries are not expected to comply with the Requirements when providing such services to their clients in in respect of non-complex products.
For the avoidance of doubt, intermediaries should comply with all applicable legal and regulatory requirements. For example, as required under paragraph 5.3 of the Code of Conduct, an intermediary, when providing services to a client in any leveraged transactions, should assure itself that the client understands the nature and risks of the products and has sufficient net worth to be able to assume the risks and bear the potential losses of trading in the products. Licensed corporations are also required to observe the requirements governing securities margin financing activities under Schedule 5 to the Code of Conduct and the Guidelines for Securities Margin Financing Activities.
A client may have contractual relationships with two different regulated entities which provide the following services:
(a) one acting as:
(i) an investment adviser (IA) and provides investment advice to the client; or
(ii) an asset manager (AM) and manages a discretionary portfolio for the client; and
(b) another acting as an execution broker and provides execution services to the client by executing the orders placed by the IA or AM on behalf of the client.
These contractual relationships, commonly known as external asset manager model and shared relationship structure, may operate under different forms. For example,
Scenario 1: The IA or AM and the execution broker may represent two different branches of a financial institution or two different legal entities within a financial group, and they are based in different jurisdictions. For instance, the IA or AM may be based in Singapore and the execution broker is based in Hong Kong.
Scenario 2: The IA or AM and the execution broker may be different legal entities and without any group relationship. The IA, AM and execution broker may all be based in Hong Kong or that only the execution broker is based in Hong Kong.
If the IA or AM places an order in a complex product (irrespective of whether the order arises from solicitation or not) on behalf of the client with an execution broker, is the execution broker required to comply with the requirements applicable to complex products under Chapter 6 of the Guidelines and paragraph 5.5 of the Code of Conduct (the Requirements) when executing the relevant transaction?
In respect of these specific scenarios, the SFC considers that the execution broker is not required to comply with the Requirements, provided the following requirements are met:
(a) the IA or AM* is licensed by or registered with the SFC or is regulated by the banking or securities regulator in the overseas jurisdiction where the investment advisory or discretionary portfolio management services are provided;
(b) the execution broker merely provides order execution and custody services to the client and has no day-to-day contact or direct communication with the client (e.g. the execution broker does not do any of the following: advises on the client’s trades, manages the client’s investment portfolio, handles the client’s enquiries on complex products or the client’s requests to trade complex products);
(c) the execution broker has agreed in writing with the IA or AM* that:
(i) in respect of the IA or AM* which is a regulated entity in the overseas jurisdiction, the IA or AM* is responsible for complying with the applicable requirements of the overseas jurisdiction before transmitting the client’s order to be executed; or
(ii) in respect of the IA or AM* which is licensed by or registered with the SFC, the IA or AM* is responsible for ensuring the suitability of a transaction in a complex product for the client and providing sufficient product information and warning statements in respect of the complex product to the client before transmitting the client’s order to be executed; and
(iii) the execution broker is not responsible for ensuring suitability of the order transmitted by the IA or AM* or providing product information and warning statements to the client; and
(d) the execution broker has ensured that the client has been informed in writing of the arrangement referred to in paragraphs (b) and (c) above.
Once the client has been informed of the arrangement pursuant to (d) above, the arrangement and the notification do not need to be repeated for each applicable transaction executed for the same client. Where there is any change to the arrangement (e.g. termination of the arrangement among the parties), the execution broker should ensure that an update is provided to the client in writing as soon as possible.
The above clarification applies to the specific scenarios set out in the answer. It does not apply to the scenario where the client requests to purchase a complex product directly with the execution broker on an unsolicited basis. When a client wishes to purchase a complex product on an unsolicited basis, the execution broker which executes the relevant transaction is required to comply with the Requirements.
Whether an intermediary acting as an execution broker is required to observe the Requirements is a question of fact which should be assessed against the circumstances of each case.
However, in no circumstances should the above-mentioned arrangement be used to circumvent the Requirements. The SFC will not hesitate to take regulatory actions against any licensed or registered person who fails to act with honesty and integrity in the best interests of its clients.
* As the case may be
Is an intermediary allowed to adopt a risk-based approach in (a) disclosing product information (including the provision of proper explanations of an investment product and the nature and extent of risks of the investment product) for solicited or recommended repeat purchases of the same investment product or investment product of the same product category; or (b) disclosing product information and providing warning statements for a transaction made by a client in complying with paragraph 5.5 of the Code of Conduct if it is a repeat purchase of the same complex product or complex product of the same product category?
When making a solicitation or recommendation of an investment product, an intermediary is required to, among others, give the client proper explanations of the investment product and the nature and extent of risks that particular investment product bears.
For complying with paragraph 5.5 of the Code of Conduct, when distributing a complex product, an intermediary is also required to, among others, disclose product information and provide warning statements to a client so as to draw the client’s attention to the key nature, features and risks of that particular complex product.
Hence, the above-mentioned disclosure should be made on a transaction-by-transaction basis. The objective of the disclosure is to ensure the client understands the product before entering into a transaction. In this regard, an intermediary may adopt a risk-based approach having regard to the circumstances, such as the client’s trading pattern, level of sophistication and investment experience, and product complexity and risk in providing the disclosure to clients.
An intermediary could design its own risk disclosure procedures for repeat transactions provided that it can be reasonably satisfied that a client has sufficient understanding of the product having regard to the aforementioned circumstances, adequacy and validity of previous disclosure made by the intermediary to the client. It is therefore important that the intermediary maintains proper record of relevant disclosure and is able to demonstrate that proper disclosure has been given to the client in previous transactions.
Intermediaries should exercise caution when designing their risk disclosure procedures for clients purchasing products which they consider to be of the same product category. This is because products of the same product category may be quite different in structure, risks, terms and conditions, etc.
How may licensed or registered persons devise their processes for (a) performing product due diligence (PDD) and (b) disclosing product information and providing warning statements to different clients, for complying with paragraph 5.5 of the Code of Conduct?
Product due diligence
If asked by a client to purchase a product which is not on the firm’s approved product list, the licensed or registered personshould perform due diligence based on all the information it obtains on a best effort basis, including product offering documents, documentation provided by the issuer and other information available in the public domain or from data providers.
Licensed or registered persons should identify the key features and risks of the product and they should:
review the product offering document or information to determine whether it is a complex product24;
if the product is a complex product, review the product information to identify its generic risks and specific risks arising from its special features; and
identify any warning flags with reference to the information obtained.
While licensed or registered persons are not expected to form a “house” view of these complex products or perform on-going PDD for complex products only made available to clients on an unsolicited basis, they should develop their policies on when the PDD needs to be re-performed or updated if the clients subsequently request to purchase the same complex products.
Disclosure of product information
When distributing a complex product, a licensed or registered person is required to disclose product information and provide warning statements to sufficiently draw clients’ attention to key features and risks. In this regard, a licensed or registered person can vary its processes and explain the product or make disclosures to the client in a proportionate and risk-based manner depending on the circumstances of each case (eg, the level of disclosure may be different if a client is very familiar with the product). Please refer to Q6B of the FAQs on Compliance with Suitability Obligationsand Q38 of this set of FAQs for further guidance.
For example, when executing an unsolicited order for a complex product for a client who has the requisite level of knowledge or experience (eg, a client who is a licensed or registered person or an investment professional employed by a fund manager), the need to provide detailed product explanations or disclosures (including warning statements) could be reduced, in some cases, substantially when warranted by the circumstances. The licensed or registered person should maintain proper records of its assessment of sophistication in these circumstances.
Where licensed or registered persons prepare and provide their own summaries of products’ key features and risks (eg, for bonds, in lieu of a product prospectus) they must ensure that all summaries are accurate and not misleading.
1 Please refer to section 114 of the Securities and Futures Ordinance (SFO). 2 Please refer to sections 114 and 115 of the SFO. 3 Including advisory services provided on a discretionary basis and automated/robo-advice. 4 For example, the SFC’s Circular to Intermediaries – Frequently Asked Questions on Triggering of Suitability Obligations, December 2016, (which may be updated from time to time). 5 Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Code of Conduct) 6 Appendix 2 to the Consultation Conclusions on the Proposed Guidelines on Online Distribution and Advisory Platforms 7 The Stock Exchange of Hong Kong Limited 8 For shares listed on the SEHK. For shares listed on overseas exchanges, this would cover the provision of a link to the relevant overseas exchange’s website or other official website. 9 Advertisements of non-complex HK government and PRC sovereign bonds with product-specific incentives would not amount to a solicitation or a recommendation. 10 For example, the Circular to Intermediaries – Frequently Asked Questions on Triggering of Suitability Obligations, SFC, December 2016. 11 For example, the SFC’s Circular to Intermediaries – Frequently Asked Questions on Triggering of Suitability Obligations, December 2016. 12 Guidance on how intermediaries should conduct PDD is provided in the Frequently Asked Questions (FAQs) on Compliance with Suitability Obligations by Licensed or Registered Persons, December 2016 (which may be updated from time to time). In particular, please see Question 4 of the FAQs. 13 Guidance on how intermediaries should conduct KYC is provided in the Frequently Asked Questions (FAQs) on Compliance with Suitability Obligations by Licensed or Registered Persons. In particular, please see Questions 2 and 3 of the FAQs. 14 Answer to Question 5 of the FAQs on Compliance with Suitability Obligations updated by the SFC. 15 Paragraph 5.2 of the Code of Conduct 16 A public fund refers to a fund which is authorized or approved for offering to retail investors by an overseas regulator. 17 With reference to 1.2 of the Code on Unit Trusts and Mutual Funds (UT Code), the SFC may accept that some schemes already comply in substance with certain provisions of the UT Code by virtue of prior authorization in a regulated jurisdiction. The list of “recognized jurisdiction schemes” so accepted are set out on the SFC’s website. 18 For guidance on the calculation methodology of the net derivative exposure of a fund, please refer to the Guide on the Use of Financial Derivative Instruments for Unit Trusts and Mutual Funds, as updated from time to time. 19Platform Operators can continue to classify SFC-authorized funds as a non-derivative fund or a derivative fund based on existing requirements until 31 December 2019. 20As supplemented by the FAQs on Triggering of Suitability Obligations and Compliance with Suitability Obligations issued by the SFC in December 2016. 21Platform Operators can continue to classify unauthorized funds as a non-derivative fund or a derivative fund based on existing requirements until 31 December 2019. 22A public fund is a fund which has been authorized or approved for offering to retail investors by a regulator. A non-public fund is thus a fund which has not been authorized or approved for offering to retail investors by a regulator (also known as a private fund). 23FAQs on Compliance with Suitability Obligations by Licensed or Registered Persons issued by the SFC in December 2016. 24 In determining whether a fund is complex or non-complex product, please make reference to Q33 and Q34 of this set of FAQs.
Last update: 23 Dec 2020