HKMA Circular on SFC Circulars Regarding Compliance with New Regulatory Requirements — HKMA — HK

Annex 1
28 May 2010
Circular to Licensed Corporations and Registered Institutions Obligations Relating to Selling / Distribution of Investment Products Post-sale cooling-off or unwind right r

The Commission's Code on Unlisted Structured Investment Products imposes an
obligation on issuers to confer on investors a right in respect of unlisted structured investment products offered to the public (except where the scheduled tenor is one year or less), whereby investors may cancel their orders, sell the product back or otherwise unwind the transaction, and receive a refund. The right is exercisable "post-sale", i.e. for a period of at least 5 business days in Hong Kong after the investor places an order.
Where an investment product confers a cooling-off or unwind right on the investor, and
the investor exercises his right, the relevant intermediary who sells or distributes such a product shall promptly execute the instruction for the client and pass on to the client the full amount of refund (including the sales commission) received from the product issuer less a reasonable administrative charge. The sales commission should include the amount retained by the distributor in relation to that transaction and the administrative charge should be disclosed at or prior to the point of sale and should not contain any profit margin.
To comply with such requirement, distributors are reminded to put in place proper
systems and procedures to facilitate their clients to exercise their rights under such mechanism. In particular, distributors are expected to pay attention to the following obligations under the Code of Conduct1:
(a) Under General Principle 5 of the Code of Conduct, distributors are required to make adequate disclosure of relevant material information in their dealings with clients. In this regard, distributors are expected to disclose the cooling-off mechanism prior to or at the point of sale (including information on how clients can exercise their cooling-off right). Where a distributor or its nominee holds the products on behalf of the clients, the information expected to be disclosed in relation to cooling-off includes the possible market value adjustment attributable to unwinding a transaction, the possibility that the clients may not be able to receive a full refund of the principal invested, what the refund (if known) will be and when the clients will receive the refund. (b) Under paragraph 2.2 of the Code of Conduct, in the general course of dealing or advising concerning a client, the provision of margin lending, and the charges, mark-ups, or fees affecting a client should be fair and reasonable in the circumstances, and be characterised by good faith. Hence, in relation to the administrative charges which are handling fees in processing the refund, they 1 Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission.

should only cover the direct processing cost and not recoupment of the sales commission or contain any profit margin. Distributors are reminded that such charges to be imposed on clients should be fair and reasonable and characterised by good faith. Other obligations relating to selling I distribution of investment products2
4. Following the publication of the Consultation Conclusions on Proposals to Enhance
Protection for the Investing Public, intermediaries are reminded to observe the following in compliance with the principles stemmed from the Code of Conduct (as revised) in the selling and distribution of investment products, including products authorized by the SFC:
Investment characteristics and risks of investment products (a) to understand the investment products (including SFC-authorized funds) that they intend to sell to their clients, including the nature of the products, the investment strategy (where applicable), the types of underlying investments, the risks involved. In particular, where an investment product may acquire financial derivative instruments for investment purposes, intermediaries are expected to be aware of the extent of the use of such instruments, and the risks involved. Notwithstanding any risk indicator or assessment of the risks of an investment product made by an issuer or as disclosed in the offering document, intermediaries are reminded to make an independent assessment of the product; Product Key Facts Statements {"Product KFS"} 3 (b) given that the Product KFS contains information about a product's key features and risks, to distribute both the Product KFS and the offering documents to clients prior to or at the point of sale; (c) intermediaries must not solely rely on the Product KFS in carrying out an independent assessment of an investment product or in advising a client the suitability of such product for the client; Language version of financial reports (d) to advise clients the language in which the financial reports of an SFC-authorized fund are prepared, for example, whether the reports are produced in English, Chinese or both languages, when marketing an SFC-authorized fund to clients; Other disclosure (e) in the case of an unlisted structured investment product offered to the public, where an issuer provides market-making, to make available indicative bid prices to clients and to promptly execute clients' orders; 2 Intermediaries are reminded to also refer to the SFC circular "Guidance to Licensed Corporations and Registered Institutions in relation to Investor Characterization and Professional Investors Requirements" issued today. 3 Product KFS are required for products authorized under the consolidated SFC Handbook for Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes and Unlisted Structured Investment Products.

(f) where distributors or their nominees hold an investment product on behalf of their clients, to disseminate or procure the dissemination of notices and other communications prepared/issued by the issuer, product arranger or management company (as the case may be) of the investment product to their clients on a timely basis upon receipt of the notices from the issuer, product arranger or the management company (as the case may be); and (g) while nominees of clients may not be the distributors themselves but affiliates of the distributors, to make arrangement with the affiliates to ensure that the information mentioned in paragraphs (e) and (f) above is disseminated to the clients. Should you have any queries regarding the contents of this circular, please contact Ms Rachel Chung on 2283 6153. Intermediaries Supervision Department Securities and Futures Commission End SFO/IS/009/2010 Tel: (852) 2840 9222 Fax: (852) 2523 4598 Website: www.sfc.hk

28 May 2010
Guidance to Licensed Corporations and Registered Institutions in relation to Investor Characterization and Professional Investors Requirements Annex2 The Commission issued the Consultation Conclusions on Proposals to Enhance Protection for the Investing Public ("Consultation Conclusions") today. The consequential amendments to the Code of Conduct1 will be published in the gazette on 4 June 2010. The purpose of these notes is to provide guidance to intermediaries in complying with the requirements in relation to investor characterization and professional investors as set out in the Consultation Conclusions. Investor characterization

Under paragraph 5.1A of the Code of Conduct, an intermediary should, as part of the
know your client procedures, 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 such knowledge. Where a client who has been characterized as without knowledge of derivatives wishes to:
(a) purchase a derivative product which is traded on an exchange and the intermediary has not solicited or provided a recommendation to the client, the intermediary should explain the risks associated with the product to the client; (b) purchase a derivative product which is not traded on an exchange and the intermediary has not solicited or provided a recommendation to the client, the intermediary should warn the client about the transaction and provide appropriate advice to the client as to whether or not the transaction is suitable for the client in all the circumstances. Criteria for assessing a client's knowledge of derivatives
An intermediary is expected to assess whether a client has general knowledge of the
nature and risks of derivatives based on information obtained from the client during the know your client procedures. It is considered that general knowledge of derivatives could assist a client to understand the nature and risks of derivative products and so enable an intermediary to provide appropriate services in relation to such products to the client. Hence, the intermediary needs to explain the risks of derivative products traded on an exchange to those clients without knowledge of derivatives but no such explanation would be required for clients with knowledge of derivatives.
Where an intermediary does not have sufficient information to determine whether a client
has knowledge of derivatives, it should adopt a conservative approach and regard that client as not having knowledge of derivatives. 1 Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission.
The following are some criteria (which are not exhaustive) for assessing if a client can be
regarded as having knowledge of derivatives:
(a) undergone training or attended courses on derivative products; (b) current or previous work experience related to derivative products; or (c) prior trading experience in derivative products.
The training or courses on derivative products may take different forms, for instance
on line or classroom courses offered by academic institutions or financial institutions, so long as they provide clients with general knowledge of the nature and risks of derivatives.
A client will be considered as having knowledge of derivatives if he has executed five or
more transactions in any derivative product (whether traded on an exchange or not), within the past three years. Explanation of risks associated with a derivative product traded on an exchange
Given that derivative products of the same type that are traded on an exchange will have
standardised features and be subject to regulation, for the purpose of complying with paragraph 5.1 A(b)(i) of the Code of Conduct, an intermediary can explain the risks associated with a type of derivative product traded on an exchange to a client without knowledge of derivatives at any stage prior to the point at which a transaction is entered into.
The types of product risks that an intermediary is required to explain may vary according
to the nature of each type of derivative product. An explanation of product risks should be specific to a particular type of derivative product which would include, for example, the fact that derivative warrants would have no value upon expiry or that for Callable Bull/Bear Contracts or CBBC, once the underlying price reaches the knock-out price, trading will be terminated immediately.
An explanation of the risks of a particular type of derivative product traded on an
exchange need only be provided once by the intermediary to the client. For repeat purchases by the client of the same type of derivative product traded on an exchange, an intermediary is not required to explain the product risks to the client again.
Where a client without derivative knowledge has previously purchased a type of
derivative product traded on an exchange but wishes to buy a different type of derivative product traded on an exchange, the intermediary is required to explain the risks associated with the different type of derivative product to the client. 11 . Any explanation to the client regarding the risks of derivative products traded on an exchange should be made in writing, whether by electronic means or otherwise. However, it is also acceptable if the explanation is audio recorded so long as a proper audit trail is maintained and the records are kept properly. It would be good practice for intermediaries to obtain the client's acknowledgement.

Providing advice to a client without knowledge of derivatives
12. For the purpose of complying with paragraph 5.1A(b)(ii) of the Code of Conduct, where
an intermediary is required to provide appropriate advice to a client as to whether or not a transaction is suitable for the client in all the circumstances, the intermediary should have regard to the factors set out in the Suitability FAQs2 issued by the Commission. Professional Investors
13. Under paragraph 15.3 of the Code of Conduct, intermediaries are required to consider all
criteria set out in paragraph 15.3(a)-(e) of the Code of Conduct. Intermediaries may adopt a holistic approach in conducting the assessment and make a reasonable decision as to whether a client could be treated as a professional investor under the Code of Conduct in the particular product and/or market in question.
14. Intermediaries may take into account all relevant and reasonable considerations in
assessing a client's knowledge and expertise under paragraph 15.3( d) of the Code of Conduct such as whether the client:
(a) is currently working or has previously worked in the relevant financial sector for at least one year in a professional position that involves the relevant product; or (b) has undergone training or studied courses which are related to the relevant product.
15. Furthermore, when providing a written explanation to a person explaining the risks and
consequences of being treated as Professional Investor under paragraph 15.4(a) of the Code of Conduct, intermediaries are reminded to include in that explanation that the intermediary will not be subject to the requirements of paragraph 5.1A of the Code of Conduct relating to know your client investor characterisation and paragraph 8.3A of the Code of Conduct relating to disclosure of sales related information. Should you have any queries regarding the contents of this circular, please contact Ms Jacquline Yip on 2840 9530. Intermediaries Supervision Department Securities and Futures Commission End SFO/IS/011/2010 2 Questions and Answers on Suitability Obligations issued by the Commission on 8 May 2007

Annex3
28 May 2010
Circular to Fund Management Companies
Investment in Financial Derivative Instruments for SFC-authorized funds The Commission issued the Consultation Conclusions on Proposals to Enhance Protection for the Investing Public ("Consultation Conclusions") today. As set out in the Consultation Conclusions, 8.9 of the revised Code on Unit Trusts and Mutual Funds will upon gazettal provide expanded investment scope for non-UCITS1 schemes to acquire financial derivative instruments for investment purposes. The management companies of SFC-authorized funds are reminded that under the Fund Manager Code of Conduct, a fund manager should maintain, among other things:
(i) sufficient human and technical resources and experience for the proper performance of its duties; and (ii) satisfactory risk management procedures commensurate with its business. In this regard, the management companies of SFC-authorized funds are reminded to put in place robust risk management policies to support their responsible investment activities. They are expected to establish and maintain effective risk management systems which are appropriate for and commensurate with the management companies' business strategies, investment activities and the funds' risk profile. Should you have any queries regarding the contents of this circular, please contact Ms Denise Chan on 2283 6188. Intermediaries Supervision Department Securities and Futures Commission End SFO/IS/010/2010 1 A "UCITS scheme" means a collective investment scheme which is already authorized under the relevant national legislation of a member state of the European Union implementing the "Council Directive 85/611/EC of 20 December 1985 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS)" (as amended).