Mystery Shopping Programme Findings

Our Ref: B1/15C
B9/103C
G16/1C

24 May 2011
The Chief Executive
All Authorized Institutions
Dear Sir / Madam,
Mystery Shopping Programme (“MSP”) Findings As announced in our circular of 18 June 2010, the Hong Kong Monetary Authority (“HKMA”) and the Securities and Futures Commission jointly engaged a service provider to undertake the MSP to assess the industry’s compliance with regulatory requirements during the sales process for unlisted securities and futures investment products and structured deposits. The report setting out the findings of the MSP for the banking sector and the securities sector is attached at Annex 1 and Annex 2, respectively. Authorized Institutions (“AIs”) should study the two reports carefully and give due regard to the issues identified in the reports when monitoring their sales process and providing training to their frontline staff. Also, AIs are encouraged to adopt the good practices set out in the two reports, if they have not already done so, to enhance their sales processes. Some sampled cases revealed areas for improvement in the disclosure of the features and risks of investment products, as well as in ensuring suitability of investment recommendations. AIs should review their systems and controls and make necessary enhancements to ensure their staff disclose sufficient and accurate information and present balanced views on investment products to help customers make informed investment decisions. AIs should also take reasonable steps to ensure that any product recommended to the customer is suitable for the customer having regard to all relevant circumstances. The management of AIs are responsible for diligently supervising their staff, and ensuring compliance with the applicable regulatory requirements. During the MSP, it was noted that some AIs’ risk profile questionnaire (“RPQ”) did not collect information about customers’ education level and/ or investment objectives. Also, the practice of their sales staff in this area varied considerably, while some asked the shoppers for the relevant information during the sales process, others did not. In the light of this, the HKMA expects AIs to collect and document, among other things, customer’s education level and investment objectives in RPQ or some other Know-Your-Client (“KYC”) document to ensure that the KYC process is conducted properly and that the relevant information is adequately taken into account in the sales process.

Areas where shortcomings were identified in the MSP will be subject to greater scrutiny in the HKMA’s supervisory process. The HKMA will continue to deploy mystery shopping from time to time to assess the industry’s compliance with regulatory requirements. Yours faithfully, Meena Datwani Executive Director (Banking Conduct) Encl. c.c. SFC (Attn: Mr Stephen Po, Senior Director of Intermediaries Supervision)

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Annex 1
Mystery Shopping Programme Findings
May 2011

Executive Summary

1. To complement its regulatory activities, the Hong Kong Monetary Authority
   (HKMA) engaged the Hong Kong Productivity Council 1 (the “Service Provider”) to carry out a mystery shopping exercise (the “Exercise”) which focused on the sales practices of retail banks for unlisted securities and futures investment products and structured deposits (collectively “Investment Products”). The Exercise covered four key areas, namely the know-your-client (KYC) process, explanation of product features and disclosure of risks, suitability assessment, and sales practices in respect of vulnerable customers.
2. The Exercise was conducted between July and November 2010, and covered 350
   samples 2 from a mix of 20 small, medium and large banks (the “Banks”), which engaged in selling Investment Products to Hong Kong investors through their branches. A report (the “Report”) summarising the findings on the sales practices of the Banks is enclosed (see Appendix).
3. The results of the Exercise revealed that the Banks generally had a high level of
   compliance with the KYC requirement. However, some of the samples revealed areas of potential concern in the sales process, in particular the lack of proper risk disclosure and not clearly providing reasonable justification for investment recommendation.
4. The HKMA has already followed up with the individual banks concerned in
   respect of the issues revealed in the Exercise. The relevant banks have been required to examine the root causes of the identified issues and to take appropriate corrective actions. Key Findings Know-Your-Client
5. In order to better understand their customer and to ensure investment suitability,
   authorized institutions (AIs) should collect from each customer relevant information that includes their financial situation, investment objectives, investment experience, investment knowledge, investment horizon, risk tolerance and education level, etc.
6. The findings of the Exercise revealed that out of the 285 samples where product
   recommendations were made, the Banks in 264 (92.6%) samples invited the

This was a joint engagement with the Securities and Futures Commission (SFC). “Sample” in this paper refers to each instance where a “shopper” acts as a potential customer to gather information on the sales process of a retail bank.

shoppers 3 to complete a risk profile questionnaire (RPQ) before introducing/ recommending the Investment Products. However, in the remaining 21 samples, the Sales Representatives (“Sales Reps”) introduced/ recommended the Investment Products before carrying out a risk profile assessment, mostly on the basis of the shoppers’ background information (e.g. age, investment objectives/ experience and expected investment return) obtained by Sales Reps during the sales process.
7. In general, the Banks’ RPQs were designed to collect customers’ information on
age, investment objectives, financial situation, investment experience and knowledge, risk tolerance level, etc. For some banks where the RPQs did not collect information on customer’s education level and/ or investment objectives, it was noted that the practices of their Sales Reps varied: while some Sales Reps asked the shoppers for the relevant information during the sales process, other Sales Reps did not. In light of this, the HKMA recommends that AIs should collect and document customer’s education level and investment objectives in RPQ or some other KYC document in order to ensure proper record and standardized practices of their sales staff.
8. All the Sales Reps across the 20 banks did not influence or pressure the shoppers
to answer any questions or change any answers to the RPQ, except for one sample where the Sales Rep suggested the shopper to choose all available answers for a question about investment horizon so as to facilitate account opening for other investment products in the future. Explanation of product features and disclosure of risks
9. In order to help each customer make informed investment decisions, AIs should
properly disclose and explain to customers the key features and risks of the investment products. In addition to explaining the benefits of the recommended products, AIs should always present balanced views, drawing their customers’ attention to the disadvantages and downside risks as well. AIs should also ensure that the explanations made by their sales staff should be fair and not misleading. Failure to make full and fair disclosure of all material features and risks of the recommended products would affect customer’s understanding of the nature of the investments and the risks involved.
10. The Exercise revealed that there was room for improvement in the disclosure of
product features and risks by the Sales Reps. The Sales Reps in most samples provided the shoppers with a general description of the risks and features of the recommended Investment Products. However, unsatisfactory practices were

“Shopper” in this paper refers to a person recruited by the Service Provider to act as a potential customer of the bank in question.

found in 5.6% of the samples involving product recommendations, where the Sales Reps failed to provide accurate or adequate information about the features and/ or risks associated with the recommended products (see paragraphs 39 – 44 of the Report).
11. In respect of structured deposits, the Exercise revealed that some Sales Reps did
not observe our requirement of disclosing the health-warning statement. In order to enhance the quality of disclosure to retail customers and apply the same principles of the SFC’s new Product Key Facts Statement measure, the HKMA has introduced the Important Facts Statement (IFS) requirement for currency￾linked and interest rate-linked instruments (including deposits) issued by AIs 4 .
12. During the Exercise, it was noted in a few instances where Investment-Linked
Assurance Scheme (ILAS) products were offered to the shoppers, Sales Reps failed to clearly explain the insurance nature and the fees and charges of the ILAS product to the shoppers. To enhance investor protection, the HKMA has further enhanced the regulatory requirements for the sales of ILAS products by AIs, including (among others) proper explanation of the nature and risks of ILAS products and ensuring customer suitability 5 . Suitability assessment
13. AIs should take all reasonable steps to ensure that any investment
recommendation made by sales staff is suitable for the customer having regard to the customer’s personal circumstances (such as investment objectives and horizon, investment experience, risk tolerance level and asset concentration, etc) together with the nature and risks of the recommended product. There should be proper controls and procedures in place to ensure that the products recommended by their sales staff are actually suitable for the customer, and are made in the best interests of the customer having regard to the customer’s own personal circumstances. The underlying rationale for such product recommendation should be properly justified and documented.
14. The findings of the Exercise revealed that although the Sales Reps generally took
into account the risk tolerance assessment results when introducing/ recommending Investment Products, most of them did not take into account all of the shoppers’ personal attributes (e.g. investment horizon). It should be noted

For details of the IFS requirement, please refer to the HKMA circular “Important Facts Statement for Currency-Linked Instruments and Interest Rate-Linked Instruments Issued by Authorized Institutions (AIs)” issued on 18 April 2011. For details of the enhanced requirements for the sales of ILAS products, please refer to the HKMA circular “Enhanced Regulatory Requirements on Selling of Investment-Linked Assurance Scheme Products” issued on 14 March 2011.

that a mechanical matching of risk rating of customers and products per se might not necessarily satisfy the requirement of suitability obligation.
15. It was noted in a few samples that the Sales Reps introduced/ recommended
Investment Products with risk ratings higher than the shoppers’ risk tolerance assessment results. These Sales Reps generally selected Investment Products solely based on the shoppers’ markets/ product preferences and/ or expected investment return without having sufficient regard to their individual circumstances and highlighting to them the risks involved in investing in the risk mis-matched products. They did not properly explain why these risk mis￾matched products were considered suitable for the shoppers, but instead they only told the shoppers that investment in risk mis-matched products required management approval. A few of these Sales Reps even advised the shoppers the justification (that the shoppers might provide to the Banks) for investing in these risk mis-matched products (see paragraphs 46 – 48 of the Report). Vulnerable customers
16. During the Exercise, 144 samples were conducted by vulnerable shoppers 6
. The
Exercise revealed that a few banks adopted a cautious approach in handling vulnerable shoppers. In 62 (43.1%) out of these 144 samples, the Sales Reps declined to introduce/ recommend any Investment Products to the vulnerable shoppers either due to unavailability of suitable Investment Products or in view of their vulnerability (old age, low education level and/ or lack of investment experience and knowledge).
17. As mentioned in Paragraph 7 above, there were some samples where the
shoppers’ education level was not collected in both the risk profile assessment and the sales processes. As a consequence, some Sales Reps were not able to identify that the shoppers were vulnerable due to low education level. Good practices
18. Good sales practices by Sales Reps were also noted during the Exercise (see
paragraphs 53-55 of the Report). For example, some Sales Reps proactively reminded the shoppers to avoid being too “aggressive” and watch out for the high investment risks involved. In some samples where the shoppers expressed difficulty in understanding the recommended Investment Products, the Sales Reps further explained the risks and features of the products to the shoppers and advised the shoppers not to make hasty investment decision.

Vulnerable shoppers refer to (i) elderly shoppers aged 65 or above; or (ii) shoppers whose education level is primary or below and who have low investment experience and low net worth.

Responses
19. For the areas and samples that revealed potential non-compliance with the
regulatory standards, the HKMA has required the banks concerned to examine the root causes of the identified issues and take appropriate corrective actions. The HKMA will continue to monitor and ensure that the relevant banks have put in place proper measures to address the identified issues. The HKMA will not hesitate to take regulatory actions for repeated material breaches.
20. The HKMA will take into account the findings of the Exercise when formulating
supervisory plan and measures. Areas where shortcomings were identified in the Exercise will be subject to greater scrutiny in the supervisory process. The HKMA will also use mystery shopping exercise as one of the regulatory tools from time to time to assess the industry’s compliance with the relevant requirements.
21. In order to promote a good compliance culture among AIs, the HKMA will issue
a circular to AIs reminding them to give due regard to the issues identified in this Exercise when AIs perform their regular compliance monitoring of the sale processes and provide training to their frontline staff.

Appendix
REPORT ON MYSTERY SHOPPING
PROGRAMME FOR THE SALE OF
UNLISTED SECURITIES AND
FUTURES INVESTMENT PRODUCTS
IN HONG KONG
BANKING SECTOR

May 2011

TABLE OF CONTENTS
1. Executive Summary ··········································································1
2. Programme Introduction····································································4
2.1 Background and Objective·········································································4
2.2 Selection of Target Banks··········································································5
2.3 Fieldwork Arrangement·············································································5
2.4 Methodology······························································································5
2.5 Profiles of Shoppers···················································································6
3. Findings ····························································································7
3.1 General·······································································································7
3.2 Know-Your-Client·····················································································9
3.3 Explanation of Product Features and Disclosure of Risks·······················12
3.4 Suitability Assessment·············································································16
3.5 Vulnerable Customers··············································································20
4. Good Practices ················································································21
5. Way Forward ··················································································23

1. EXECUTIVE SUMMARY
1. A service provider 1
was engaged to carry out a mystery shopping exercise.
This report summarizes the findings of the exercise which focused on sales practices for unlisted securities and futures investment products (“Investment Products”). In respect of the banking sector, the scope of Investment Products was expanded to include structured deposits.
2. The exercise was carried out between July and November 2010. During this
period, a total of 350 samples 2 were conducted on 20 retail banks (“the banks”).
3. The mystery shopping exercise revealed that the banks, to some extent, were in
compliance with the regulatory requirements, except for some isolated samples. The banks in general had a high level of compliance with the Know-Your-Client (“KYC”) requirement, but there were areas such as risks disclosure and suitability assessments that required further enhancement by the banks. The major findings of this report are summarized in the following paragraphs:
Know-Your-Client
4. In 92.6% of the samples involving product recommendations, the sales
representatives (“Sales Reps”) invited the shoppers 3 to complete a risk profile questionnaire (“RPQ”) before introducing / recommending the Investment Products. However, in the remaining small number of samples, some of the shoppers’ attributes (particularly the investment objectives and / or education level) were not collected by the Sales Reps.

All references to service provider in this report refer to us – Hong Kong Productivity Council “Sample” in this report refers to each instance where a “shopper” acts as a potential customer to gather information on the sales process of a retail bank “Shopper” in this report refers to a person recruited by the service provider to act as a potential customer of the bank in question

5. With the exception of one sample, the Sales Reps properly collected information
   from the shopper. In the exceptional sample, the Sales Rep suggested the shopper to choose all available answers for a question about investment horizon in order to facilitate opening of investment accounts for various products in the future. Explanation of product features and disclosure of risks by the Sales Reps
6. Sales Reps generally recommended the shoppers to invest in mutual funds
   (mainly those with the underlying investment being equities or bonds). In some samples, structured deposits (mostly currency-linked) or debt securities (mostly renminbi bonds) were recommended to the shoppers.
7. Most Sales Reps provided the shoppers with a general description of the risks
   and features of the recommended Investment Products. However, in 5.6% of the samples, the Sales Reps did not provide sufficient or accurate information about the features and / or risks of the products to the shoppers.
8. For structured deposits, the Sales Reps generally disclosed the nature, basic
   features and major risks and explained that the structured deposits were not principal-protected. Some Sales Reps did not highlight to the shoppers that the structured deposits were not equivalent to time deposits. In particular, most Sales Reps did not draw the shoppers’ attention to the “health-warning” statement 4 .

The “health-warning” statement: “This is a structured product involving derivatives. The investment decision is yours but you should not invest in the [product name / type] unless the intermediary who sells it to you has explained to you that the product is suitable for you having regard to your financial situation, investment experience and investment objectives”.

Suitability assessment
9. In 285 (81.4%) out of the 350 samples, the Sales Reps introduced /
recommended Investment Products to the shoppers. For the remaining 65 (18.6%) samples, the Sales Reps refrained from introducing / recommending any Investment Products to the shoppers if they were vulnerable shoppers 5 or if suitable Investment Products were unavailable.
10. Most Sales Reps introduced / recommended the Investment Products mainly
based on the shoppers’ risk tolerance assessment results and did not take into account all the relevant personal circumstances of the shoppers (e.g. investment horizon).
11. Some Sales Reps did not perform proper suitability assessment and introduced /
recommended the Investment Products solely based on the shoppers’ markets preferences and expected return without having sufficient regard to the shoppers’ personal circumstances. These Sales Reps usually did not provide proper justifications for the suitability of the recommended products. Vulnerable customers
12. In a number of samples involving product recommendations for vulnerable
shoppers, the Sales Reps did not introduce another Sales Rep to the shoppers and / or invite the shoppers to bring along witnesses to help ensure that they understood the product features and risks. Good practices
13. Good sales practices by the Sales Reps were also noted during this exercise. A
few Sales Reps proactively reminded the shoppers to avoid being too “aggressive” and watch out for the high investment risks involved, as well as advised the shoppers not to make hasty investment decisions.

Vulnerable shoppers refer to (i) elderly shoppers aged 65 or above; or (ii) shoppers whose education level is primary or below and who have low investment experience and low net worth.

2. PROGRAMME INTRODUCTION
2.1 BACKGROUND AND OBJECTIVE
14. In their respective reports to the Financial Secretary in December 2008 on issues
arising from the Lehman Minibonds incident, both the HKMA and the Securities and Futures Commission (SFC) (described together as “the Regulators”) recommended the introduction of a Mystery Shopping Programme (“MSP”). These recommendations were made with the intent of enhancing the existing regulatory framework by providing an additional supervisory tool to oversee the practices of regulated entities selling investment products in Hong Kong.
15. The Regulators have jointly engaged a service provider to assist them in
implementing the MSP covering the sale of unlisted securities and futures investment products (“Investment Products”) in Hong Kong.
16. In respect of the banking sector, taking into account the popularity of structured
deposits (e.g. currency-linked deposits and interest rate-linked deposits) among retail customers, the scope of Investment Products under the MSP was expanded to include structured deposits as well.
17. The MSP complements the Regulators’ regulatory activities by helping to assess
whether the Sales Reps are complying with the applicable rules and regulations when selling Investment Products to investors in Hong Kong.

2.2 SELECTION OF TARGET BANKS
18. In order to better gauge the prevailing market practices, the HKMA selected a
mix of small, medium and large banks which engaged in selling Investment Products to Hong Kong investors through their branches. A total of 341 retail branches of 20 banks were selected as target samples.
2.3 FIELDWORK ARRANGEMENT
19. The fieldwork was carried out between July and November 2010.
2.4 METHODOLOGY
20. The MSP focused on three key areas, namely the KYC process, explanation of
product features and disclosure of risks, and suitability assessment. For the banking sector, the MSP also covered sales practices in respect of vulnerable customers.
21. Shoppers acting as potential customers were deployed throughout the MSP
exercise to visit and assess the banks. The shoppers used their real personal particulars (including name, age and address). The service provider provided training to the shoppers on product information, securities regulation, sales practices of retail banks, and how to complete the shopper questionnaire.
22. A shopper questionnaire was designed by the Regulators to document the
shoppers’ experiences during their visits to the banks. Each shopper was required to complete and submit the questionnaire to the service provider after the visit.

23. Specific instructions were provided to the shoppers on how to approach the
banks and act during the customer interview. In this regard, the shoppers were asked to express interest in Investment Products and have face-to-face meetings with the Sales Reps. However, the shoppers were not required to make any actual investments. The shoppers would record what happened during the meetings, complete the questionnaires and collect any materials provided by the Sales Reps.
24. During the mystery shopping exercise, the service provider carried out quality
control tests and checked all completed questionnaires against the relevant records to ensure the completeness and accuracy of the questionnaires.
2.5 PROFILES OF SHOPPERS
25. The MSP covered shoppers with different attributes, for example:
(a) Age: young adult, middle aged or the elderly (aged 65 or above); (b) Risk appetite: high, medium or low; (c) Financial net worth: ranging from low net worth (less than HKD 500,000) to high net worth (more than HKD 2,000,000); (d) Educational background: illiterate, primary education to tertiary education level; and (e) Investment experience: from no investment experience to more than 5 years of investment experience.

3. FINDINGS
3.1 GENERAL
26. In 348 (99.4%) out of the 350 samples, it was observed that the product sales
process was conducted in the designated “investment corner”, which was physically segregated from the ordinary banking business area. For the other two samples, the shoppers observed that the product sales process was conducted either in the bank’s customer service corner or in the branch manager’s room outside the “investment corner”.
27. In 17 (4.9%) out of the 350 samples, the Sales Reps of a few banks requested the
shoppers to sign off a consent form to allow the banks’ sales staff to access and utilize the shoppers’ deposit information for investment and wealth management purpose even though the shoppers did not have any deposit account with the banks.
28. Out of the 350 samples, the Sales Reps recommended Investment Products to the
shoppers in 285 samples (81.4%). For the remaining 65 (18.6%) samples, most Sales Reps either (i) refused to provide investment services to the vulnerable shoppers in view of their old age, low education level and / or lack of investment experience; or (ii) refused to introduce / recommend any Investment Products to the vulnerable shoppers due to unavailability of suitable products after taking into account the shoppers’ low risk tolerance assessment results.
29. The sales practice of a few banks was found to be different across their Sales
Reps. Some Sales Reps required the shoppers to open a bank account before conducting risk profile assessment and introducing / recommending Investment Products. In respect of the risk profile assessment process, the Sales Rep might either (i) invite the shopper to conduct the risk profile assessment by a non-sales staff or via a calling centre with audio-recording; (ii) conduct the risk profile assessment for the shopper without audio-recording; (iii) invite the shopper to conduct the risk profile assessment by himself without audio-recording; or (iv)

not invite the shopper to conduct the risk profile assessment at all before product recommendations. The lack of uniformity of sales practices may cause operational difficulty for sales compliance monitoring.

3.2 KNOW-YOUR-CLIENT
General Observations
30. In 264 (92.6%) out of the 285 samples involving product recommendations, the
Sales Reps invited the shoppers to complete an RPQ before introducing / recommending the Investment Products. It was found that in 11 banks, all the shoppers were invited to complete an RPQ before the Sales Reps introduced / recommended Investment Products. Figure 1 shows the number of samples where risk profile assessment was not conducted before product recommendation.
Figure 1: Number of samples where risk profile assessment was NOT conducted
before product recommendation
No. of samples where risk profile assessment was NOT conducted before product recommendation No. of banks Nil 11 1 3 2 3 3 1 4 1 5 1 Total no. of samples where risk profile assessment was NOT conducted before product recommendation Total no. of banks involved 21 9 Base: 285 samples involving product recommendations

31. In general, the banks’ RPQs contained questions which were aimed at collecting
    customers’ information on their age, investment objectives, investment horizon, financial situation, investment experience and knowledge, as well as risk tolerance level. For some banks where the RPQs did not collect information on customer’s education level and / or investment objectives, it was noted that the practices of their Sales Reps varied: while some Sales Reps asked the shoppers for the relevant information during the sales process, other Sales Reps did not.
32. In 262 (96.0%) out of the 273 samples where RPQs were completed and product
    recommendations were involved, the risk profile assessment processes were audio-recorded, except that some Sales Reps of seven banks conducted the risk profile assessments for the shoppers without audio-recording. These Sales Reps usually indicated to the shoppers that a risk profile assessment by a non-sales staff with audio-recording would only be conducted upon product purchase. Nevertheless, the Sales Reps confirmed the risk tolerance assessment results with the shoppers in all these 273 samples.
33. The Sales Reps across the 20 banks generally provided a copy of the RPQ to the
    shoppers, except for a few isolated samples of nine banks and for some branches of a bank with a usual practice of destroying the RPQ record before the shoppers left the branch premises so long as the shoppers were not the bank’s customers. Therefore, a copy of the RPQ was not provided to the shoppers for the latter case.

Other Observations
34. With the exception of one sample (see Example 1 below), it was observed that
all the Sales Reps across the 20 banks did not influence or pressure the shoppers to answer any questions or change any answers to the RPQ. Example 1:
After knowing that the shopper was interested in investing in funds with higher returns, the bank staff appeared to have exerted undue influence on the shopper in answering the question of investment horizon in the RPQ. In order to facilitate account opening for other investment products (e.g. stocks and currency-linked products) in future, the bank staff suggested the shopper to choose all available answers for a question about investment horizon.

3.3 EXPLANATION OF PRODUCT FEATURES AND
DISCLOSURE OF RISKS
General Observations
35. In the 285 samples involving 659 product recommendations, the Sales Reps
introduced / recommended 561 (85.1%) mutual funds (mainly those with the underlying investment in equities or bonds) to the shoppers. 84 structured deposits (12.7%) and 11 debt securities (1.7%) were recommended in the other samples.
36. In respect of mutual funds, the Sales Reps in general disclosed the funds’ basic
information (e.g. the region of investment and the nature of the underlying assets), their historical performance as well as the relevant fees and charges. However, in 5.6% of the samples, the Sales Reps did not provide sufficient or accurate information about the features and / or risks of the products to the shoppers.
37. In respect of structured deposits (mostly currency-linked), the Sales Reps in
general disclosed the nature, basic features and major risks of the structured deposits. However, in some samples, the Sales Reps did not highlight and explain to the shoppers the lock-in feature as well as the termination conditions relating to the structured deposits. The Sales Reps generally drew to the shoppers’ attention and explained that the structured deposits were not principal-protected, but some Sales Reps did not highlight to the shoppers that the structured deposits were not equivalent to time deposits. In particular, most Sales Reps did not draw the shoppers’ attention to the “health-warning” statement.
38. In respect of debt securities (mostly renminbi bonds), the Sales Reps in general
disclosed the nature, features and major risks involved, but some of them did not explain the features of lock-in period and termination conditions.

Other Observations
39. In 5.6% of the samples, the Sales Reps did not provide proper and adequate
information about the features and / or risks of the recommended Investment Products to the shoppers to help shoppers make informed investment decisions. The following examples highlight the deficiencies noted. Provision of inaccurate information about recommended products
40. In one sample, the Sales Rep indicated to the shopper that the recommended
equity-linked deposit required the shopper to receive the underlying equity (i.e. physical delivery) if the final price fell below 95% of the strike price, but in fact it was 100% capital-protected and would be settled in cash only.
41. In one sample, the Sales Rep indicated to the shopper that the quoted return was
on a monthly basis, but in fact it was an annual return. In a few other samples, the Sales Reps told the shoppers that the mutual funds were issued by the bank, but in fact they were issued by the bank’s related company.
42. During the mystery shopping exercise, we noted a few instances where
Investment-Linked Assurance Scheme (“ILAS”) products were offered to the shoppers. Some of these Sales Reps did not clearly explain to the shoppers whether the recommended Investment Products were mutual funds or underlying funds of an ILAS product, which was a life insurance policy.

Inadequate disclosure of the recommended products
43. Some Sales Reps did not present balanced views and focused only on good
points (e.g. good historical performance and popularity among investors) without drawing the shoppers’ attention to the disadvantages and downside risks of the recommended Investment Products (see below for an example). Example 3:
The Sales Rep failed to draw the shopper’s attention to the disadvantages and downside risks of the recommended mutual fund. Throughout the sales process, the Sales Rep merely focused on the advantages of investing into the fund and repeatedly represented that the fund outperformed the Hang Seng Index over the past years. The investment risks involved were not mentioned. Example 2:
Due to unclear explanation by the Sales Rep, it was difficult for the shopper to understand whether the recommended Investment Product was a mutual fund or an underlying fund of an ILAS. On one hand, the Sales Rep provided an ILAS product brochure to the shopper, which included the recommended product as one of the underlying funds available for investors to choose for such ILAS product, but did not disclose the “insurance” nature (if any) of the recommended product throughout the sales process. On the other hand, the Sales Rep indicated to the shopper that the recommended product could be redeemed and turned into cash anytime. If the recommended product was an ILAS product, such description was not appropriate given the high penalty fees during its lock-in period. In fact, the Sales Rep did not mention the fees and charges in the sales process.

44. A Sales Rep (see Example 4 below) failed to provide adequate disclosure and
    explanation about the product features and risks of a mutual fund to a shopper. Example 4:
    The Sales Rep disclosed to the shopper the 3-year lock-in period, the guaranteed coupon for the first year and the coupons for each of the remaining two years would be based on the performance of 2823.HK (i.e. A50 China Index ETF). However, the Sales Rep did not mention to the shopper the underlying constituents of the fund (including a swap arrangement and the corresponding counterparty default risk), and the risks of investing in China A-share market (including the synthetic nature of the A50 China Index ETF). The Sales Rep also did not explain to the shopper how the potential coupons for the second and the third years of the investment period would be linked to the performance of 2823.HK (i.e. the coupon calculation mechanism).

3.4SUITABILITY ASSESSMENT
General Observations
45. For the samples where the RPQs were completed with an overall client risk
rating and product recommendations were involved, most Sales Reps introduced / recommended the Investment Products mainly based on the shoppers’ risk tolerance assessment results and did not take into account all of the shoppers’ personal attributes (e.g. investment horizon). Nevertheless, all these samples did not involve risk mis-matched products.
46. There were a few samples where the Sales Reps introduced / recommended
Investment Products with risk ratings higher than the shoppers’ risk tolerance assessment results. These Sales Reps generally selected Investment Products solely based on the shoppers’ markets / products preferences and / or expected investment return without having sufficient regard to their risk tolerance assessment results as well as highlighting to them the risks involved in investing in the risk mis-matched products and the potential unsuitability.
47. As mentioned in Section 3.2, there were 21 samples (7.4%) of 9 banks where the
Sales Reps introduced / recommended the Investment Products before carrying out a risk profile assessment. Instead of inviting these shoppers to complete an RPQ, these Sales Reps usually introduced / recommended the Investment Products either based on (i) shoppers’ background information (e.g. investment objectives, investment experience and / or expected investment return); or (ii) the popularity and performance of the products and / or the lower level of risk involved in the bond funds or RMB bonds.
48. Among these 21 samples, a few Sales Reps subsequently invited the shoppers to
conduct an RPQ and found that the products recommended earlier involved a risk mis-match. However, these Sales Reps did not recommend other Investment Products to the shoppers with due regard to the RPQ assessment results. Instead, the Sales Reps only told the shoppers that investment in risk mis-matched products required management approval and advised the shoppers

the justification (that the shoppers might provide to the banks) for investing in these risk mis-matched products. The Sales Reps did not draw the shoppers’ attention to the risks involved in investing in the risk mis-matched products and explain why these risk mis-matched products were considered suitable for the shoppers (see below for examples). Example 5:
Based on the shopper’s previous investment experiences, the Sales Rep recommended two Investment Products before carrying out a risk profile assessment. The risk profile assessment was subsequently conducted. Upon the shopper’s enquiry for the risk ratings of the recommended products, the Sales Rep replied that she had joined the bank for 3 months and was not familiar with the bank’s system, so she could not retrieve from the system the risk ratings of the recommended products. The Sales Rep then indicated to the shopper that “it does not matter even if your risk tolerance assessment result does not match with the product risk rating, as you would just need to sign-off a risk mis-match acknowledgement afterwards. The most important thing is the performance of the product. Let me show you the performance record.”. The rationale for recommending the two Investment Products was not explained.

Example 6:
After knowing the shopper's expected investment horizon of 3 to 5 years, the Sales Rep recommended two mutual funds (with underlying investments in China market) with product risk ratings of "5" to the shopper before carrying out a client risk profile assessment. Risk profile assessment was subsequently conducted and the resultant client risk tolerance level was "4", which was lower than the risk rating of the two recommended funds (i.e. risk mis-matched products). The Sales Rep only indicated to the shopper that the recommended funds were of higher risks than her risk tolerance assessment result but did not explain the rationale underlying the investment recommendation. Instead, the Sales Rep advised the shopper that the justification (that the shopper may provide to the bank) for investing in the higher risk products could be: “You understand that the China market is volatile but it is your preference”. Given that the shopper did not indicate her preferred investment / market (e.g. China market) to the Sales Rep, the basis for the Sales Rep’s recommendation of the two funds was questionable. Example 7:
The shopper indicated that she was not interested in insurance products. However, the Sales Rep introduced / recommended two mutual funds with the highest product risk rating underlying an ILAS product to the shopper, taking into account the shopper's expected investment horizon of 3 years and expected annual investment return of 10%. The Sales Rep neither invited the shopper to carry out a client risk profile assessment nor mentioned the “insurance” nature of the recommended ILAS during the sales process. The basis for the Sales Rep’s recommendation was questionable. Further, the Sales Reps did not present balanced views and mainly focused on the advantages and good performance of the recommended funds underlying the ILAS product.

Other Observations
49. For a few banks adopting the “portfolio” wealth management approach and
introduced / recommended the risk mis-matched Investment Products to the shoppers, the Sales Reps in some samples did not draw the shoppers’ attention to the risk mis-match and did not advise the shoppers to avoid concentration in the recommended higher risk product(s).

3.5 VULNERABLE CUSTOMERS
50. Among the 350 samples, 144 (41.1%) samples of the 20 banks were conducted
by the vulnerable shoppers. Out of these 144 samples, 62 (43.1%) samples of 18 banks did not involve product recommendations as the Sales Reps declined to introduce / recommend any Investment Products to the vulnerable shoppers either due to unavailability of suitable Investment Products or in view of their old age, education level and / or lack of investment experience and knowledge.
51. Out of the remaining 82 (56.9%) samples involving product recommendations to
the vulnerable shoppers, there were a number of samples where the Sales Reps did not introduce another Sales Rep to the shoppers and / or invite the shoppers to bring along witnesses to confirm the shoppers’ understanding of the product risks and features.
52. Some Sales Reps were not able to identify that the relevant shoppers were
vulnerable (with low education level) because the shoppers’ education level was neither collected in the RPQ nor otherwise enquired by the Sales Reps throughout the sales process.

4. GOOD PRACTICES
53. Good sales practices by Sales Reps were also noted during this exercise. Sales
Reps in general did not introduce / recommend Investment Products of risk ratings higher than the shoppers’ risk tolerance assessment results and / or of risk return profile that did not match with the shoppers’ investment objectives, investment horizon and investment experiences, etc. In samples where the shoppers requested for some Investment Products that were either of risk ratings higher than the shopper’s risk tolerance or assessed to be not suitable for the shoppers by the Sales Reps, the respective Sales Rep highlighted to the particular shopper the following:
(a) The requested products were of higher risk rating than his / her risk tolerance assessment result and drew to the shopper’s attention that the products might not be suitable for him / her in view of the risk mis-match; (b) if the shopper decided on his / her own volition to invest in the product, the shopper should ensure that he / she has sufficient net worth to assume the risks and bear the potential losses of trading in these higher risk products; (c) the shopper was required to provide adequate justification for his / her choice of the products and to sign his / her acknowledgement of the risk mis-match; and (d) the relevant risk mis-matched sales transaction would have to be subject to management approval.
54. In some samples where the shoppers expressed difficulty in understanding the
recommended Investment Products, the Sales Reps further explained the risks and features of the products with the relevant product leaflets to the shoppers and advised the shoppers not to make hasty investment decision.

55. In samples conducted by the elderly shoppers, some Sales Reps proactively
reminded the shoppers to watch out for the high investment risks involved and not to be too “aggressive” even though the shoppers were assessed with the highest risk tolerance after conducting the client risk profiling.

5. WAY FORWARD
56. The SFC has already set out the requirements governing sales practices in the
Code of Conduct 6
, Internal Control Guidelines 7 and the Suitability FAQs 8 .
The HKMA has also issued circulars to banks on supplementary requirements. The HKMA may wish to consider reminding the banks to put in place proper controls and procedures to ensure compliance with the relevant regulatory requirements regarding the selling of Investment Products to investors in Hong Kong.
57. In particular, banks should be reminded to provide their customers with enough
relevant information to make informed investment decisions. Such information would include providing customers with an accurate explanation of product features and risks. Banks should also carry out proper suitability assessments and provide regular training to their sales staff so as to equip them with regularly updated and complete information about the Investment Products they sell and the relevant regulatory guidelines and requirements. Furthermore, banks should perform effective monitoring of the sales process.
58. Regarding the examples and areas of potential non-compliance that have been
highlighted in this report, the HKMA may wish to follow up these with the banks concerned and require the banks in question to take appropriate action to address the issues noted.

Code of Conduct for Persons Licensed by or Registered with the SFC Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the SFC Questions and Answers on Suitability Obligations

59. The HKMA is advised to take into account the experiences and observations
    gained in this exercise when designing similar mystery shopping programmes in the future.

---

Mystery Shopping Programme Findings
May 2011
Annex 2

Executive Summary

1. To complement its regulatory activities, the Securities and Futures Commission (the SFC)
   has engaged the Hong Kong Productivity Council 1 to carry out a mystery shopping exercise (the Exercise), which focuses on the selling practices of licensed corporations involving unlisted securities and futures investment products (Securities Products). The Exercise covers three key areas, namely know-your-client (KYC), explanation of product features and disclosure of risks, and suitability assessment.
2. The Exercise was carried out between July and November 2010. During the period, a total
   of 150 samples 2 were conducted on 10 selected licensed corporations (with 15 samples each). The SFC selected both investment advisory firms and brokerage firms that sell Securities Products to retail customers, including walk-in customers. A report (the Report) summarising the findings on the selling practices of these selected firms is enclosed (see
   Appendix).
3. The Exercise revealed that the selected firms generally complied with the KYC
   requirements, although in two instances, the practices of sales staff of a firm were found to have undermined the KYC process.
4. The Exercise has shown that there are gaps in the quality of explanation of features and
   disclosure of risks concerning the products recommended. Unsatisfactory practices were found in 16% of the cases where products were recommended to shoppers 3 . These included sales staff demonstrating insufficient understanding of the recommended products and the provision of insufficient or even inaccurate information to the shoppers. In this regard, licensed corporations must pay due regard to the needs of their clients and to help them make informed decisions by providing appropriate and accurate information to them.
5. There is also room for improvement in respect of the suitability assessments carried out by
   the selected firms. It was noted in some instances that the sales staff did not take into account all the relevant personal circumstances of the shoppers when making the recommendation. In addition, the sales staff generally did not sufficiently explain why the products were suitable for the shoppers having regard to their individual circumstances. Key Findings Know-Your-Client
6. Intermediaries are required under the Code of Conduct 4
   to seek information from clients about their financial situation, investment experience and investment objectives. In order to better understand this client information, intermediaries are also required to collect from each client information about their investment knowledge, investment horizon and risk tolerance, etc 5 .

This was a joint engagement with the Hong Kong Monetary Authority “Sample” in this paper refers to each instance where a “shopper” acts as a potential customer to gather information on the sales process of a licensed corporation “Shopper” in this paper refers to a person recruited by the service provider to act as a potential customer of the firm in question Paragraph 5.1 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Code of Conduct) Question 2 of the Questions and Answers on Suitability Obligations (Suitability FAQs) issued by the SFC on 8 May 2007

7. The findings of the Exercise revealed that while the selected firms generally complied with
   the KYC requirements, there was room for improvement in this area for some of them. (i) Undermining KYC process

8. In two instances, sales staff from a firm were found to guide or hint to the shoppers to
   change their answers in the risk profile questionnaires so that a wider range of products could be recommended to them (see paragraph 25 of the Report). Deficient KYC and risk profile assessment would result in recommending unsuitable products to clients. While this happened in only one of the selected firms, the SFC would still like to highlight this practice. The SFC will not tolerate such a practice as it undermines the suitability regime. The licensed corporation concerned was required to take immediate measures including a review of its controls and procedures to ensure that the KYC process is properly conducted. (ii) Failure to obtain certain key client information

9. In certain samples, some of the shoppers’ attributes, in particular investment horizon (19%
   of the samples) and risk appetite (12% of the samples) were not collected beforehand (see paragraph 23 of the Report). Without obtaining the essential client information, it is questionable how the sales staff could assess whether the recommended products are suitable to the clients’ specific circumstances. (iii) Failure to properly address investors’ enquiries

10. In another two cases, sales staff were not able to answer investors’ enquiries when
    conducting the KYC process and assessing the risk profile of the shoppers (see paragraphs 26 and 27 of the Report). This casts doubt on whether the sales staff are familiar with the risk profile assessment methodology adopted by their firm or even appreciate the importance of the KYC procedure. Explanation of product features and disclosure of risks

11. In order to ensure that investment recommendations to clients are reasonably suitable,
    intermediaries are required to help the client make informed decisions by giving the client a proper explanation of the basis of the investment recommendation, as well as the nature and extent of the risks the investment products bear. Intermediaries should always present balanced views about the investment products including drawing the client’s attention to the disadvantages and downside risks. 6

12. The Exercise has shown that more efforts should be made to improve the overall quality of
    explanation of features and disclosure of risks provided by the sales staff. The improper practices noted are summarised below. (i) Insufficient understanding of products

13. Some sales staff did not demonstrate sufficient understanding of the recommended
    products. They were not able to properly advise the shoppers of the underlying investments of the recommended funds, eg, the countries or types of shares that the funds invested in (see paragraphs 33 and 34 of the Report). Without truly understanding the features and risks of the products they recommend, it would be difficult for the sales staff to properly discharge their suitability obligations to clients.

Question 5 of the Suitability FAQs

(ii) Providing insufficient information
14. Some sales staff failed to provide sufficient information about the recommended products to
the shoppers, such as, the features and risks of the products, relevant fees and charges, and whether a secondary market was available for the recommended debt securities (see paragraph 35 of the Report). Failure to make full and fair disclosure of all material features of the recommended products would affect clients’ understanding of the nature of the investments and the risks involved. (iii) Providing inaccurate information
15. It was noted in some instances that the sales staff provided inaccurate information to the
shoppers (see paragraphs 36 and 37 of the Report). For example, a sales consultant represented that investing in funds was a low risk form of investment and was even more secure than placing deposits with banks. In fact, the level of risks could vary from high to low depending on the characteristics and underlying investments of specific funds. It is incorrect to represent to the investor that investment in any funds would be more secure than placing deposits with banks. Clients rely on sales staff’s advice when they invest. Sales staff have a duty to act in the best interest of the clients and should provide accurate information to them for making investment decisions.
16. During the Exercise, it was also noted that some sales staff provided a wrong interpretation
of the SFC’s requirements or practices (see paragraph 38 of the Report). For example, a sales consultant wrongly represented to the shopper that the SFC would categorise investment products into different risk groups. This would give a wrong impression to the clients that the SFC has endorsed the way that the firm categories its products. Suitability assessment
17. Suitability involves matching the risk return profile of each recommended investment
product with each client’s personal circumstances. The facts and circumstances of each case differ and it is a matter for the sales staff to use their professional judgment to diligently assess whether the characteristics and risk exposures of each recommended product are actually suitable for the client concerned and are in the best interests of the client, taking into account the client’s personal circumstances 7 . The following deficiencies in relation to suitability assessment were noted in the Exercise. (i) Insufficient explanation of rationale behind recommendation
18. The sales staff generally did not sufficiently explain why the products were suitable for the
shoppers having regard to their individual circumstances. Failure to provide a clear rationale for product recommendations would make it difficult for clients to assess whether the recommendations are suitable for them.
19. In some samples, the risk level of the recommended products was higher than the risk
appetite of the shoppers but the sales staff did not explain why the recommended products were considered suitable for the shopper (see paragraph 41 of the Report).

Question 4 of the Suitability FAQs

(ii) Recommending products to clients without proper regard to their specific circumstances
20. It was noted in some instances that the sales staff did not take into account all the relevant
personal circumstances of the shopper when making the assessment (see paragraph 42 of the Report). In one case, the sales staff even advised the shopper that she could buy any investment product since she had experience in trading stocks. Such an advice is incorrect. Prior experience in trading of stocks does not mean that it is appropriate for the customer to invest in any type of investment product. Good practices
21. Good selling practices by sales staff were also noted during the Exercise (see paragraphs
43 to 45 of the Report). For example, some sales staff advised the shoppers to diversify their investments, or to start investing in small amounts at different times so as to limit their risks. Other sales staff exercised extra care in dealing with elderly customers and young or inexperienced investors. Responses
22. The SFC places great emphasis on industry’s compliance with the selling practices
requirements set out in the Code of Conduct, Internal Control Guidelines 8 and the Suitability FAQs. The results of the Exercise revealed that licensed corporations have gaps in complying with the regulatory requirements. Licensed corporations should critically review their systems and controls to ensure full compliance with the relevant regulatory requirements. In particular, the management of licensed corporations should exercise appropriate oversight over the selling practices of their sales staff.
23. For licensed corporations where major deficiencies were noted in the Exercise, the SFC has
required the firms in question to take actions to address those deficiencies. The SFC will continue to monitor these firms and to ensure that they have put in place appropriate measures to address the issues noted. The SFC will not hesitate to take regulatory actions for repeated material breaches.
24. The SFC will also take into account the findings of the Exercise when updating our
supervisory regime regarding selling practices. The mystery shopping exercise will be used as one of our regulatory tools from time to time to assess industry’s compliance with the relevant requirements. Areas where shortcomings are identified in the Exercise will be subject to greater scrutiny during our inspection visits.

Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the SFC

REPORT ON MYSTERY SHOPPING
PROGRAMME FOR THE SALE OF
UNLISTED SECURITIES AND
FUTURES INVESTMENT
PRODUCTS IN HONG KONG
SECURITIES SECTOR
April 2011
Appendix

Table of Contents
1. Executive Summary ·········································································· 2
2. Programme Introduction ···································································· 4
2.1 Background and Objective ·········································································· 4
2.2 Selection of Target Firms ············································································ 4
2.3 Fieldwork Arrangement···············································································4
2.4 Methodology································································································4
2.5 Profiles of Shoppers ····················································································· 5
3. Findings ···························································································· 6
3.1 Know-Your-Client (“KYC”)······································································· 6
3.2 Explanation of Product Features and Disclosure of Risks ·························· 9
3.3 Suitability Assessment ··············································································· 15
4. Good Practices ················································································17
5. Way Forward ··················································································18

1. EXECUTIVE SUMMARY
1. A service provider 1
has been engaged to carry out a mystery shopping exercise.
This report summarizes the findings of the exercise which focuses on selling practices involving unlisted securities and futures investment products (“Securities Products”).
2. The exercise was carried out between July and November 2010. During this
period, a total of 150 samples 2 were conducted on 10 selected licensed corporations (with 15 samples each).
3. The mystery shopping exercise revealed that the selected firms generally
complied with the Know-Your-Client (“KYC”) requirements although in two instances, the practices of sales consultants of a firm were found to have undermined the KYC process. Deficiencies were also noted in other areas such as explanation of product features to customers, disclosure of risks and suitability assessments. The major findings of this report are summarized in the following paragraphs:
Know-Your-Client
4. Sales consultants from the selected firms collected shopper 3
information through a mix of verbal discussion and the use of risk profile questionnaires. The information obtained generally included the shopper’s investment objectives, financial situation and investment experience. However, in some samples, the sales consultants failed to collect relevant information such as the shopper’s investment horizon and risk appetite during the KYC process.
5. Two sales consultants from the same firm were found to have guided or hinted
to shoppers to change their answers in the risk profile questionnaire so that a wider range of investment products could be recommended to them.

All references to service provider in this report refer to us – Hong Kong Productivity Council “Sample” in this report refers to each instance where a “shopper” acts as a potential customer to gather information on the sales process of a licensed corporation “Shopper” in this report refers to a person recruited by the service provider to act as a potential customer of the firm in question

Explanation of product features and disclosure of risks by sales consultants
6. Shoppers were generally recommended by the selected firms to invest in
mutual funds (mainly those with the underlying investment being equities or bonds).
7. Most sales consultants provided shoppers with a general description of the
features and risks of the products recommended. However, in 16% of the samples where recommendations were made to shoppers, it was noted that the sales consultants:
(a) provided inaccurate or insufficient information about the features and/or risks of the products to the shoppers; (b) did not demonstrate sufficient understanding of the products being recommended to the shoppers; or (c) provided inaccurate descriptions regarding the requirements or practices of the Securities and Futures Commission (“SFC”). Suitability assessment
8. In the majority of samples, (95% or 142 out of 150 samples), the sales
consultants ended up recommending specific products to shoppers. In the remaining 8 samples involving 3 firms, the sales consultants declined to recommend any products to shoppers after carrying out the KYC procedures. They advised the shoppers that no products matched their risk profiles.
9. When making a suitability assessment and considering investment products to
recommend, firms are required to take into account the customer’s personal circumstances. In this regard, it was noted in some samples that the sales consultants did not take into account all the relevant personal circumstances of the shopper (e.g. investment horizon and risk appetite) when making a suitability assessment.
10. Good selling practices by sales consultants were also noted during this
exercise. Some sales consultants advised the shoppers to diversify their investments, or to start investing in small amounts at different times so as to limit their risks. Other sales consultants exercised extra care in handling elderly customers and young or inexperienced investors.

2. PROGRAMME INTRODUCTION
2.1 BACKGROUND AND OBJECTIVE
11. In respective reports sent to the Financial Secretary in December 2008 on
“Issues raised by the Lehmans Minibonds crisis”, both the SFC and the Hong Kong Monetary Authority (“HKMA”) (described together as the “Regulators”) recommended the introduction of a Mystery Shopping Programme (“MSP”). These recommendations were made with the intent of enhancing the existing regulatory framework by providing an additional supervisory tool to oversee the practices of regulated entities selling investment products in Hong Kong.
12. The Regulators have jointly engaged a service provider to assist them in
implementing the MSP covering the sale of unlisted securities and futures investment products (“Securities Products”) in Hong Kong.
13. The MSP complements the Regulators’ regulatory activities by helping to
assess whether sales consultants are complying with the Regulators’ rules and regulations when selling Securities Products to investors in Hong Kong.
2.2 SELECTION OF TARGET FIRMS
14. A total of 150 samples were conducted on 10 selected licensed corporations
(with 15 samples each). The firms selected included both investment advisory firms and brokerage firms. The firms selected by the SFC are those that sell Securities Products to retail customers, including walk-in customers.
2.3 FIELDWORK ARRANGEMENT
15. The fieldwork was carried out between July and November 2010.
2.4 METHODOLOGY
16. The MSP focused on 3 key areas, namely KYC procedures, explanation of
product features and disclosure of risks, and suitability assessment.
17. Shoppers acting as potential customers were used throughout the MSP

exercise to visit and assess the selected firms. The shoppers used their real personal particulars (including name, age and address). The service provider provided training to shoppers on product information, securities regulation, selling practices of licensed firms, and how to complete the shopper questionnaire.
18. A shopper questionnaire was designed by the Regulators to document the
shoppers’ experiences during their visits to selected firms. Each shopper was required to complete and submit the questionnaire to the service provider after their visit.
19. Specific instructions were provided to the shoppers on how to approach the
firms and act during the customer interview. In this regard, the shoppers were asked to express interest in Securities Products and have face-to-face meetings with the firms’ sales consultants. However, the shoppers were not required to make any actual investments. The shoppers would record what happened during the meetings, complete the questionnaires and collect any materials provided by the sales consultants.
20. During the mystery shopping exercise, the service provider carried out quality
control tests and checked all completed questionnaires against the relevant records to ensure the completeness and accuracy of the questionnaires.
2.5 PROFILES OF SHOPPERS
21. The MSP covered shoppers with different attributes, for example:
(a) Age: young adult, middle aged or the elderly; (b) Risk appetite: high, medium or low; (c) Financial net worth: ranging from low net worth (less than HKD 500,000) to high net worth (more than HKD 2,000,000); (d) Educational background: primary, secondary or tertiary education level; and (e) Investment experience: from no investment experience to more than 5 years of investment experience.

3. FINDINGS
3.1 KNOW-YOUR-CLIENT (“KYC”)
General Observations
22. Out of 150 samples, 80 samples (53%) of the shoppers’ personal information
was collected through verbal discussion only, and in 70 samples (47%) the shoppers’ personal information was obtained by the sales consultants via the firm’s standard risk profile questionnaire and through verbal discussion with the shoppers.
23. It was observed that in most samples, the sales consultants collected
information regarding shoppers’ investment objectives, investment experience and financial situation during the KYC process. However, in certain samples, some of the shoppers’ attributes were not collected (particularly investment horizon (19%) and risk appetite (12%)) before the sales consultants recommended products to the shoppers.
Figure 1: No. of samples where certain customer information was NOT collected
by sales consultants
Investment objective
Investment horizon
Financial situation
Investment experience
Risk appetite
No. of samples 14 28 7 4 18
Base total 150
% 9% 19% 5% 3% 12%

Other Observations
24. Key information about shoppers was obtained during the KYC process, but
improper practices were noted in some samples. The major deficiencies noted are described below. Guiding shoppers to make changes to the answers of questionnaires
25. 2 sales consultants from the same firm (see below) guided or hinted to the
shoppers to change their answers in the risk profile questionnaires so that a wider range of investment products could be recommended to them. Example 1: After introducing some funds to the shopper, the sales consultant requested the shopper to mark her risk appetite in the firm’s standard risk profile questionnaire. The shopper originally chose a risk level of “5” (Medium High) out of a total of 9 risk tolerance levels. However, the sales consultant indicated that she would be unable to invest in most of the funds if she chose level “5”. The sales consultant suggested the shopper to choose “7” (Very High) and even “8” (Speculative) given the shopper had invested in stocks. The shopper read the descriptions in the questionnaire and noted that level “8” was for speculative investors who would invest in products such as warrants. The shopper told the sales consultant that she had not invested in warrants. The sales consultant then concluded that the shopper should choose “7” without explaining how he arrived at this rating. Example 2: The shopper completed a risk profile questionnaire indicating her risk tolerance level was 5 (“Medium High”). The sales consultant advised her to select a higher risk level because the shopper might want to maintain a high-risk account in the future. The shopper then changed her original risk tolerance level to 6 (“High”). When the sales consultant noticed that the shopper had selected capital protection as one of the investment objectives, he suggested the shopper not to choose that option. The sales consultant had incorrectly represented to the shopper that only by not choosing this option would the licensed corporation comply with the SFC regulations.

Failure to properly address shopper’s enquiry
26. In one sample, the shopper was assessed as an “aggressive” customer after
completion of the firm’s risk profile questionnaire, but the shopper queried why she was assessed as such and advised that she would only accept a medium risk rating. The sales consultant responded that the assessment was to comply with SFC’s regulatory requirements and if she were graded at a low risk level, she may not be able to invest even in equity funds. What the sales consultant should have done is to properly explain the risk profiling method or approach to the shopper and advise her regarding the options available if she did not agree to the final risk rating.
27. In another sample, the sales consultant did not properly address the shopper’s
enquiry when conducting the risk profile assessment. The shopper asked if the firm’s risk profiling questionnaire was effective. Instead of explaining the basis adopted by the firm in developing its questionnaire, the sales consultant simply mentioned that the risk profile questionnaire had been reviewed by the Regulator.

3.2 EXPLANATION OF PRODUCT FEATURES AND DISCLOSURE OF RISKS
General Observations
28. In the majority of samples, (95% or 142 out of 150 samples), the sales
consultants ended up recommending specific products to shoppers. In the remaining 8 samples involving 3 firms, the sales consultants declined to recommend any Securities Products to the shoppers after they performed the KYC procedures. They advised the shoppers that no products matched their risk profiles.
29. Shoppers were generally recommended by the selected firms to invest in
mutual funds (mainly those with the underlying investment being equities or bonds). In 5 samples involving 3 firms, the sales consultants also recommended corporate bonds to the shoppers. In one sample, an ELN was also recommended to the shopper.
30. Regarding mutual funds / unit trusts products that were recommended, the
sales consultants usually mentioned the funds’ basic information (e.g. the region of investment and the nature of the underlying assets), their historical performance and the relevant fees and charges. However, in some samples, the sales consultants did not provide sufficient or accurate information about the features and/or risks associated with the products to the shoppers.
31. For corporate bonds that were recommended, the sales consultants provided
shoppers with basic information regarding the products but some did not mention whether there was a secondary market available for the recommended bonds or say anything about the credit risk of the issuers. Other Observations
32. In 16% of the samples where recommendations were made to the shoppers, it
was noted that the sales consultants did not properly explain the features and/or risks of the products to the shoppers. The following observations highlight the deficiencies noted.

Insufficient understanding of the recommended products
33. In some samples, the sales consultants did not demonstrate sufficient
understanding of the recommended products or the fund factsheets. For example, when a shopper asked about the meaning of an “Indian Subcontinent Fund (ٱ৫ڻՕຬഗ८*”, the sales consultant did not appear familiar with the underlying investments and replied that the fund invested in second-tier stocks but not large-cap stocks. In fact, the Indian subcontinent generally refers to the countries of India, Pakistan, Bangladesh and Sri Lanka, and according to the fund factsheet, the fund also had investments in large cap stocks.
34. In another sample, a sales consultant wrongly advised that the fund in question
only invested in H shares but not A shares. The shopper noted from the factsheet that the fund did in fact invest in A shares and pointed out the error to the sales consultant. Insufficient disclosure about Securities Products
35. Some sales consultants did not provide sufficient information about the
recommended products to the shoppers, such as the features and risks of the product, relevant fees and charges and whether a secondary market was available (for debt securities). For example:
(a) A sales consultant did not provide a clear explanation of the leverage nature of a fund. (b) Some sales consultants did not explain the fund details to the shopper. (c) In a sample where corporate bonds were recommended, certain key features about corporate bonds such as the issuer’s credit risk and whether a secondary market was available were not disclosed to the shopper. (d) Some sales consultants did not sufficiently explain the disadvantages and downside risks of the recommended products and/or did not disclose information about product fees and charges to the shopper when recommending the product (see below for examples).

Example 3: The sales consultant constructed 2 investment portfolios for the shopper (aged about 50 with moderate risk appetite, targeted for capital growth and with experience in securities trading). Graphs of yearly performance relative to market index were presented to the shopper as illustration which indicated a negative 3-year return against 3-year volatility for the recommended portfolios. The shopper enquired why the portfolios had a negative return and whether she would make a loss if she invested in this portfolio. The sales consultant did not directly address the shopper’s query but responded that those negative returns were just some numbers for the shopper’s reference and she could ignore them. In fact, the sales consultant failed to disclose the downside risks of the investment to the shopper. Example 4: The shopper (aged 20-30 with high risk appetite and some investment experience) enquired about the fees and charges and the sales consultant advised that the upfront fee was generally around 3% but it would vary among different funds. The sales consultant also mentioned that once the shopper had decided on which funds to invest in, they would check the details for him; but at that point in time the shopper only had to decide which funds/areas he wanted to invest in. The sales consultant failed to provide relevant information regarding the fees and charges of each fund to the shopper. During the selling process, the sales consultant only described the market risk of the funds to the shopper. At the conclusion of their meeting, the shopper was asked to sign a risk declaration form acknowledging that all investments bear risks as read out by the sales consultant, which included credit risk, market risk, foreign exchange risk (use USD or EURO to calculate prices) and liquidity risk (cannot turn investments into cash quickly). The sales consultant then stated that he had already mentioned the risks of the products. The sales consultant should not merely read out to the customer a list of the different types of risks inherent to investment products but should provide proper explanations on the nature and extent of the risks of the products that have been recommended.

Provision of inaccurate information about Securities Products
36. Some sales consultants provided inaccurate information about the
recommended products to the shoppers. For example:
(a) A sales consultant wrongly advised the shopper that one of his recommended funds was an eligible investment under the HKSAR Capital Investment Entrant Scheme when in fact it was not. (b) Another sales consultant suggested that investing in funds was a low risk form of investment and was even more secure than placing deposits with banks. (c) In some samples where the shoppers were recommended to invest in investment products provided by insurance companies, the sales consultants had not clearly explained to the shoppers that the recommended product was an investment-linked assurance scheme i.e. an insurance policy.
37. Some sales consultants failed to properly explain the features, disadvantages
and downside risks of the Securities Products to the shoppers (see below for examples).

Example 5: A shopper (a 74-year old retired woman with low risk appetite, having about HK$1M in fixed deposits) accompanied by her daughter was recommended to invest in a life insurance policy and a portfolio of funds. The sales consultant briefly mentioned about the products’ names and their historical performance but did not elaborate on details of the specific markets and types of stocks that the recommended products invested in. In addition, one of the recommended funds was a fund primarily invested in futures and options which according to this fund’s prospectus would be subject to key risk factors including leverage, counterparty and liquidity risks and substantial losses may be suffered. However, the sales consultant did not tell the shopper about these risk factors. He even told the shopper that this fund was one which could avoid risk (“䙓䱾෎䞥”) and would be more secure. The shopper’s daughter sought clarification and enquired if the sales consultant’s explanation of “avoiding risk” (“䙓䱾”) meant that investors could avoid risks when they invested in this fund during market turmoil. The sales consultant replied in the positive. When the shopper’s daughter further questioned how the fund could avoid risks, the sales consultant simply responded that it was due to the fund manager’s capability, but did not explain the fund’s investment or risk management strategies to the shopper. Example 6: When explaining the risks involved in “traditional mutual funds” to a shopper (aged 20-30 with some investment experience and a high risk appetite), the sales consultant said that the shopper would not lose all of his investment by investing in funds because the risks involved were minimal. In explaining the downside risks of the funds, the sales consultant advised that if the shopper invested in 5 funds on a long-term basis, even if only 2 funds could perform well, he could still make a profit. The sales consultant incorrectly informed the shopper that the upward movement in some of the funds would always be more than enough to cover the downward movement of the other funds.

Provision of inaccurate information about the SFC’s requirements or practices
38. Some sales consultants provided inaccurate information about the SFC’s
requirements or practices. For example, the sales consultants in 2 samples had wrongly claimed that the SFC would categorise investment products into different risk groups, and one of them also incorrectly represented to the investor that the SFC, when considering whether a licensed corporation has properly complied with the suitability obligation, would only match the risk rating of the product with the investor’s risk appetite without considering the amount invested having regard to the investor’s total net worth (i.e. concentration risk).

3.3 SUITABILITY ASSESSMENT
Observations
39. In general, the sales consultants usually gave brief explanations of why the
recommended products were suitable for the shoppers, but they did not sufficiently elaborate on why the products were suitable for the shoppers having regard to their individual circumstances.
40. As mentioned in Section 3.1, in some samples, the risk assessment result
might not properly reflect the shopper’s risk profile due to the shopper being guided or hinted to change her answer in the risk profile questionnaire and the shopper disagreeing with the final assessment result which stated that she had a higher risk profile. This might potentially result in unsuitable products being recommended to shoppers.
41. In some samples, the risk level of the recommended products was higher than
the risk appetite of the shopper but the sales consultant did not explain why the recommended products were considered suitable for the shopper (see below for an example of such a situation). Example 7: A middle-aged housewife with a few years’ experience in investing in stocks and bonds, was recommended to invest in products having higher risk (mutual funds in emerging markets and natural resources market) than her preferred risk appetite (“low to medium”). The sales consultant was aware of the mismatch between the shopper’s risk appetite and the risk profile of the products. The sales consultant pointed out to the shopper that the recommended portfolio was riskier than shopper’s past investment and stressed that the funds were selected because of their big upward potential, but he did not explain why they were suitable for the shopper.
42. Some sales consultants had not taken into account the personal circumstances
of the shoppers when making investment recommendations. For example, (a) It was not explained why corporate bonds issued by some PRC property

development and construction companies would be suitable for a retiree with a medium risk appetite. (b) A shopper informed the sales consultant that she did not want her money to be locked-in after the sales consultant recommended her to invest in funds via an investment platform with a lock-in period of 5 years. However, the sales consultant did not propose other investment alternatives. He simply ignored the shopper’s liquidity needs and told her that there was no way to work around the issue because that was how the investment platform worked. (c) A sales consultant (see example below) claimed that the shopper had the necessary experience for buying investment products but whether this was, in fact, the sample was questionable. Example 8: The shopper (a housewife with some investment experience and medium risk appetite) enquired whether some investment products would not be available to her, based on her personal circumstances. The sales consultant explained that the shopper could buy any investment products since she had experience in trading of stocks which attracted the highest risk rating. Prior experience in trading of stocks does not mean that it is appropriate for the customer to invest in any type of investment product.

4. GOOD PRACTICES
43. Good selling practices by sales consultants were also noted during this
exercise. In some samples, it was noted that the sales consultants had advised the shoppers to diversify their investments or not to invest a significant amount into any single fund product or products with high volatility. Some shoppers were also advised to start investing in small amounts at different times so as to limit their risks.
44. In other samples, the sales consultants reminded shoppers of various issues
regarding their individual circumstances:
(a) A shopper without any investment experience was reminded of the SFC’s quote to “learn before you invest” and was advised to attend some courses. (b) A few young shoppers were advised to invite family members to come along to assist in reviewing the investment plan or strategies. A sales consultant advised a young shopper that she should not invest in an investment product if she was not familiar with its nature. (c) Some shoppers who were assessed as aggressive investors were reminded by sales consultants to watch out for the risks involved even though the risk profile assessment indicated that they could assume high risks.
45. A few sales consultants also exercised extra care in advising elderly or retired
shoppers, advising them on one or more of the following points:
(a) A more conservative risk appetite should be adopted and investments should not be made in high risk products. (b) Principal protection should be set as the major investment objective. (c) Ensure that there was no short term liquidity needs before making the investment, so as to avoid unnecessary financial pressure on oneself. (d) Investment ideas should be shared with family members before reaching a final decision on whether to invest.

5. WAY FORWARD
46. The SFC has already set out the requirements governing selling practices in
the Code of Conduct 4
, Internal Control Guidelines 5 and the Suitability FAQs 6 .
It should consider reminding licensed firms in the securities sector to put in place proper controls and procedures to ensure compliance with the relevant regulatory requirements regarding the selling of investment products to investors in Hong Kong.
47. In particular, firms should be reminded to provide their customers with enough
relevant information to make informed investment decisions. Such information would include providing customers with an accurate explanation of product features and risks. Firms should also carry out proper suitability assessments and provide regular training to their sales staff so as to equip them with regularly updated and complete information about the Securities Products they sell and the relevant regulatory guidelines and requirements. Furthermore, firms should perform effective monitoring of the sales process.
48. Regarding the examples and areas of potential non-compliance that have been
highlighted in this report, the SFC may wish to follow up these with the licensed firms concerned and require the firms in question to take appropriate action to address the issues noted.
49. The SFC is advised to take into account the experiences and observations
gained in this exercise when designing similar mystery shopping programmes in the future.

Code of Conduct for Persons Licensed by or Registered with the SFC Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the SFC Questions and Answers on Suitability Obligations

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Appendix
REPORT ON MYSTERY SHOPPING
PROGRAMME FOR THE SALE OF
UNLISTED SECURITIES AND
FUTURES INVESTMENT PRODUCTS
IN HONG KONG
BANKING SECTOR

May 2011

TABLE OF CONTENTS
1. Executive Summary ··········································································1
2. Programme Introduction····································································4
2.1 Background and Objective·········································································4
2.2 Selection of Target Banks··········································································5
2.3 Fieldwork Arrangement·············································································5
2.4 Methodology······························································································5
2.5 Profiles of Shoppers···················································································6
3. Findings ····························································································7
3.1 General·······································································································7
3.2 Know-Your-Client·····················································································9
3.3 Explanation of Product Features and Disclosure of Risks·······················12
3.4 Suitability Assessment·············································································16
3.5 Vulnerable Customers··············································································20
4. Good Practices ················································································21
5. Way Forward ··················································································23

1. EXECUTIVE SUMMARY
1. A service provider 1
was engaged to carry out a mystery shopping exercise.
This report summarizes the findings of the exercise which focused on sales practices for unlisted securities and futures investment products (“Investment Products”). In respect of the banking sector, the scope of Investment Products was expanded to include structured deposits.
2. The exercise was carried out between July and November 2010. During this
period, a total of 350 samples 2 were conducted on 20 retail banks (“the banks”).
3. The mystery shopping exercise revealed that the banks, to some extent, were in
compliance with the regulatory requirements, except for some isolated samples. The banks in general had a high level of compliance with the Know-Your-Client (“KYC”) requirement, but there were areas such as risks disclosure and suitability assessments that required further enhancement by the banks. The major findings of this report are summarized in the following paragraphs:
Know-Your-Client
4. In 92.6% of the samples involving product recommendations, the sales
representatives (“Sales Reps”) invited the shoppers 3 to complete a risk profile questionnaire (“RPQ”) before introducing / recommending the Investment Products. However, in the remaining small number of samples, some of the shoppers’ attributes (particularly the investment objectives and / or education level) were not collected by the Sales Reps.

All references to service provider in this report refer to us – Hong Kong Productivity Council “Sample” in this report refers to each instance where a “shopper” acts as a potential customer to gather information on the sales process of a retail bank “Shopper” in this report refers to a person recruited by the service provider to act as a potential customer of the bank in question

5. With the exception of one sample, the Sales Reps properly collected information
   from the shopper. In the exceptional sample, the Sales Rep suggested the shopper to choose all available answers for a question about investment horizon in order to facilitate opening of investment accounts for various products in the future. Explanation of product features and disclosure of risks by the Sales Reps
6. Sales Reps generally recommended the shoppers to invest in mutual funds
   (mainly those with the underlying investment being equities or bonds). In some samples, structured deposits (mostly currency-linked) or debt securities (mostly renminbi bonds) were recommended to the shoppers.
7. Most Sales Reps provided the shoppers with a general description of the risks
   and features of the recommended Investment Products. However, in 5.6% of the samples, the Sales Reps did not provide sufficient or accurate information about the features and / or risks of the products to the shoppers.
8. For structured deposits, the Sales Reps generally disclosed the nature, basic
   features and major risks and explained that the structured deposits were not principal-protected. Some Sales Reps did not highlight to the shoppers that the structured deposits were not equivalent to time deposits. In particular, most Sales Reps did not draw the shoppers’ attention to the “health-warning” statement 4 .

The “health-warning” statement: “This is a structured product involving derivatives. The investment decision is yours but you should not invest in the [product name / type] unless the intermediary who sells it to you has explained to you that the product is suitable for you having regard to your financial situation, investment experience and investment objectives”.

Suitability assessment
9. In 285 (81.4%) out of the 350 samples, the Sales Reps introduced /
recommended Investment Products to the shoppers. For the remaining 65 (18.6%) samples, the Sales Reps refrained from introducing / recommending any Investment Products to the shoppers if they were vulnerable shoppers 5 or if suitable Investment Products were unavailable.
10. Most Sales Reps introduced / recommended the Investment Products mainly
based on the shoppers’ risk tolerance assessment results and did not take into account all the relevant personal circumstances of the shoppers (e.g. investment horizon).
11. Some Sales Reps did not perform proper suitability assessment and introduced /
recommended the Investment Products solely based on the shoppers’ markets preferences and expected return without having sufficient regard to the shoppers’ personal circumstances. These Sales Reps usually did not provide proper justifications for the suitability of the recommended products. Vulnerable customers
12. In a number of samples involving product recommendations for vulnerable
shoppers, the Sales Reps did not introduce another Sales Rep to the shoppers and / or invite the shoppers to bring along witnesses to help ensure that they understood the product features and risks. Good practices
13. Good sales practices by the Sales Reps were also noted during this exercise. A
few Sales Reps proactively reminded the shoppers to avoid being too “aggressive” and watch out for the high investment risks involved, as well as advised the shoppers not to make hasty investment decisions.

Vulnerable shoppers refer to (i) elderly shoppers aged 65 or above; or (ii) shoppers whose education level is primary or below and who have low investment experience and low net worth.

2. PROGRAMME INTRODUCTION
2.1 BACKGROUND AND OBJECTIVE
14. In their respective reports to the Financial Secretary in December 2008 on issues
arising from the Lehman Minibonds incident, both the HKMA and the Securities and Futures Commission (SFC) (described together as “the Regulators”) recommended the introduction of a Mystery Shopping Programme (“MSP”). These recommendations were made with the intent of enhancing the existing regulatory framework by providing an additional supervisory tool to oversee the practices of regulated entities selling investment products in Hong Kong.
15. The Regulators have jointly engaged a service provider to assist them in
implementing the MSP covering the sale of unlisted securities and futures investment products (“Investment Products”) in Hong Kong.
16. In respect of the banking sector, taking into account the popularity of structured
deposits (e.g. currency-linked deposits and interest rate-linked deposits) among retail customers, the scope of Investment Products under the MSP was expanded to include structured deposits as well.
17. The MSP complements the Regulators’ regulatory activities by helping to assess
whether the Sales Reps are complying with the applicable rules and regulations when selling Investment Products to investors in Hong Kong.

2.2 SELECTION OF TARGET BANKS
18. In order to better gauge the prevailing market practices, the HKMA selected a
mix of small, medium and large banks which engaged in selling Investment Products to Hong Kong investors through their branches. A total of 341 retail branches of 20 banks were selected as target samples.
2.3 FIELDWORK ARRANGEMENT
19. The fieldwork was carried out between July and November 2010.
2.4 METHODOLOGY
20. The MSP focused on three key areas, namely the KYC process, explanation of
product features and disclosure of risks, and suitability assessment. For the banking sector, the MSP also covered sales practices in respect of vulnerable customers.
21. Shoppers acting as potential customers were deployed throughout the MSP
exercise to visit and assess the banks. The shoppers used their real personal particulars (including name, age and address). The service provider provided training to the shoppers on product information, securities regulation, sales practices of retail banks, and how to complete the shopper questionnaire.
22. A shopper questionnaire was designed by the Regulators to document the
shoppers’ experiences during their visits to the banks. Each shopper was required to complete and submit the questionnaire to the service provider after the visit.

23. Specific instructions were provided to the shoppers on how to approach the
banks and act during the customer interview. In this regard, the shoppers were asked to express interest in Investment Products and have face-to-face meetings with the Sales Reps. However, the shoppers were not required to make any actual investments. The shoppers would record what happened during the meetings, complete the questionnaires and collect any materials provided by the Sales Reps.
24. During the mystery shopping exercise, the service provider carried out quality
control tests and checked all completed questionnaires against the relevant records to ensure the completeness and accuracy of the questionnaires.
2.5 PROFILES OF SHOPPERS
25. The MSP covered shoppers with different attributes, for example:
(a) Age: young adult, middle aged or the elderly (aged 65 or above); (b) Risk appetite: high, medium or low; (c) Financial net worth: ranging from low net worth (less than HKD 500,000) to high net worth (more than HKD 2,000,000); (d) Educational background: illiterate, primary education to tertiary education level; and (e) Investment experience: from no investment experience to more than 5 years of investment experience.

3. FINDINGS
3.1 GENERAL
26. In 348 (99.4%) out of the 350 samples, it was observed that the product sales
process was conducted in the designated “investment corner”, which was physically segregated from the ordinary banking business area. For the other two samples, the shoppers observed that the product sales process was conducted either in the bank’s customer service corner or in the branch manager’s room outside the “investment corner”.
27. In 17 (4.9%) out of the 350 samples, the Sales Reps of a few banks requested the
shoppers to sign off a consent form to allow the banks’ sales staff to access and utilize the shoppers’ deposit information for investment and wealth management purpose even though the shoppers did not have any deposit account with the banks.
28. Out of the 350 samples, the Sales Reps recommended Investment Products to the
shoppers in 285 samples (81.4%). For the remaining 65 (18.6%) samples, most Sales Reps either (i) refused to provide investment services to the vulnerable shoppers in view of their old age, low education level and / or lack of investment experience; or (ii) refused to introduce / recommend any Investment Products to the vulnerable shoppers due to unavailability of suitable products after taking into account the shoppers’ low risk tolerance assessment results.
29. The sales practice of a few banks was found to be different across their Sales
Reps. Some Sales Reps required the shoppers to open a bank account before conducting risk profile assessment and introducing / recommending Investment Products. In respect of the risk profile assessment process, the Sales Rep might either (i) invite the shopper to conduct the risk profile assessment by a non-sales staff or via a calling centre with audio-recording; (ii) conduct the risk profile assessment for the shopper without audio-recording; (iii) invite the shopper to conduct the risk profile assessment by himself without audio-recording; or (iv)

not invite the shopper to conduct the risk profile assessment at all before product recommendations. The lack of uniformity of sales practices may cause operational difficulty for sales compliance monitoring.

3.2 KNOW-YOUR-CLIENT
General Observations
30. In 264 (92.6%) out of the 285 samples involving product recommendations, the
Sales Reps invited the shoppers to complete an RPQ before introducing / recommending the Investment Products. It was found that in 11 banks, all the shoppers were invited to complete an RPQ before the Sales Reps introduced / recommended Investment Products. Figure 1 shows the number of samples where risk profile assessment was not conducted before product recommendation.
Figure 1: Number of samples where risk profile assessment was NOT conducted
before product recommendation
No. of samples where risk profile assessment was NOT conducted before product recommendation No. of banks Nil 11 1 3 2 3 3 1 4 1 5 1 Total no. of samples where risk profile assessment was NOT conducted before product recommendation Total no. of banks involved 21 9 Base: 285 samples involving product recommendations

31. In general, the banks’ RPQs contained questions which were aimed at collecting
    customers’ information on their age, investment objectives, investment horizon, financial situation, investment experience and knowledge, as well as risk tolerance level. For some banks where the RPQs did not collect information on customer’s education level and / or investment objectives, it was noted that the practices of their Sales Reps varied: while some Sales Reps asked the shoppers for the relevant information during the sales process, other Sales Reps did not.
32. In 262 (96.0%) out of the 273 samples where RPQs were completed and product
    recommendations were involved, the risk profile assessment processes were audio-recorded, except that some Sales Reps of seven banks conducted the risk profile assessments for the shoppers without audio-recording. These Sales Reps usually indicated to the shoppers that a risk profile assessment by a non-sales staff with audio-recording would only be conducted upon product purchase. Nevertheless, the Sales Reps confirmed the risk tolerance assessment results with the shoppers in all these 273 samples.
33. The Sales Reps across the 20 banks generally provided a copy of the RPQ to the
    shoppers, except for a few isolated samples of nine banks and for some branches of a bank with a usual practice of destroying the RPQ record before the shoppers left the branch premises so long as the shoppers were not the bank’s customers. Therefore, a copy of the RPQ was not provided to the shoppers for the latter case.

Other Observations
34. With the exception of one sample (see Example 1 below), it was observed that
all the Sales Reps across the 20 banks did not influence or pressure the shoppers to answer any questions or change any answers to the RPQ. Example 1:
After knowing that the shopper was interested in investing in funds with higher returns, the bank staff appeared to have exerted undue influence on the shopper in answering the question of investment horizon in the RPQ. In order to facilitate account opening for other investment products (e.g. stocks and currency-linked products) in future, the bank staff suggested the shopper to choose all available answers for a question about investment horizon.

3.3 EXPLANATION OF PRODUCT FEATURES AND
DISCLOSURE OF RISKS
General Observations
35. In the 285 samples involving 659 product recommendations, the Sales Reps
introduced / recommended 561 (85.1%) mutual funds (mainly those with the underlying investment in equities or bonds) to the shoppers. 84 structured deposits (12.7%) and 11 debt securities (1.7%) were recommended in the other samples.
36. In respect of mutual funds, the Sales Reps in general disclosed the funds’ basic
information (e.g. the region of investment and the nature of the underlying assets), their historical performance as well as the relevant fees and charges. However, in 5.6% of the samples, the Sales Reps did not provide sufficient or accurate information about the features and / or risks of the products to the shoppers.
37. In respect of structured deposits (mostly currency-linked), the Sales Reps in
general disclosed the nature, basic features and major risks of the structured deposits. However, in some samples, the Sales Reps did not highlight and explain to the shoppers the lock-in feature as well as the termination conditions relating to the structured deposits. The Sales Reps generally drew to the shoppers’ attention and explained that the structured deposits were not principal-protected, but some Sales Reps did not highlight to the shoppers that the structured deposits were not equivalent to time deposits. In particular, most Sales Reps did not draw the shoppers’ attention to the “health-warning” statement.
38. In respect of debt securities (mostly renminbi bonds), the Sales Reps in general
disclosed the nature, features and major risks involved, but some of them did not explain the features of lock-in period and termination conditions.

Other Observations
39. In 5.6% of the samples, the Sales Reps did not provide proper and adequate
information about the features and / or risks of the recommended Investment Products to the shoppers to help shoppers make informed investment decisions. The following examples highlight the deficiencies noted. Provision of inaccurate information about recommended products
40. In one sample, the Sales Rep indicated to the shopper that the recommended
equity-linked deposit required the shopper to receive the underlying equity (i.e. physical delivery) if the final price fell below 95% of the strike price, but in fact it was 100% capital-protected and would be settled in cash only.
41. In one sample, the Sales Rep indicated to the shopper that the quoted return was
on a monthly basis, but in fact it was an annual return. In a few other samples, the Sales Reps told the shoppers that the mutual funds were issued by the bank, but in fact they were issued by the bank’s related company.
42. During the mystery shopping exercise, we noted a few instances where
Investment-Linked Assurance Scheme (“ILAS”) products were offered to the shoppers. Some of these Sales Reps did not clearly explain to the shoppers whether the recommended Investment Products were mutual funds or underlying funds of an ILAS product, which was a life insurance policy.

Inadequate disclosure of the recommended products
43. Some Sales Reps did not present balanced views and focused only on good
points (e.g. good historical performance and popularity among investors) without drawing the shoppers’ attention to the disadvantages and downside risks of the recommended Investment Products (see below for an example). Example 3:
The Sales Rep failed to draw the shopper’s attention to the disadvantages and downside risks of the recommended mutual fund. Throughout the sales process, the Sales Rep merely focused on the advantages of investing into the fund and repeatedly represented that the fund outperformed the Hang Seng Index over the past years. The investment risks involved were not mentioned. Example 2:
Due to unclear explanation by the Sales Rep, it was difficult for the shopper to understand whether the recommended Investment Product was a mutual fund or an underlying fund of an ILAS. On one hand, the Sales Rep provided an ILAS product brochure to the shopper, which included the recommended product as one of the underlying funds available for investors to choose for such ILAS product, but did not disclose the “insurance” nature (if any) of the recommended product throughout the sales process. On the other hand, the Sales Rep indicated to the shopper that the recommended product could be redeemed and turned into cash anytime. If the recommended product was an ILAS product, such description was not appropriate given the high penalty fees during its lock-in period. In fact, the Sales Rep did not mention the fees and charges in the sales process.

44. A Sales Rep (see Example 4 below) failed to provide adequate disclosure and
    explanation about the product features and risks of a mutual fund to a shopper. Example 4:
    The Sales Rep disclosed to the shopper the 3-year lock-in period, the guaranteed coupon for the first year and the coupons for each of the remaining two years would be based on the performance of 2823.HK (i.e. A50 China Index ETF). However, the Sales Rep did not mention to the shopper the underlying constituents of the fund (including a swap arrangement and the corresponding counterparty default risk), and the risks of investing in China A-share market (including the synthetic nature of the A50 China Index ETF). The Sales Rep also did not explain to the shopper how the potential coupons for the second and the third years of the investment period would be linked to the performance of 2823.HK (i.e. the coupon calculation mechanism).

3.4SUITABILITY ASSESSMENT
General Observations
45. For the samples where the RPQs were completed with an overall client risk
rating and product recommendations were involved, most Sales Reps introduced / recommended the Investment Products mainly based on the shoppers’ risk tolerance assessment results and did not take into account all of the shoppers’ personal attributes (e.g. investment horizon). Nevertheless, all these samples did not involve risk mis-matched products.
46. There were a few samples where the Sales Reps introduced / recommended
Investment Products with risk ratings higher than the shoppers’ risk tolerance assessment results. These Sales Reps generally selected Investment Products solely based on the shoppers’ markets / products preferences and / or expected investment return without having sufficient regard to their risk tolerance assessment results as well as highlighting to them the risks involved in investing in the risk mis-matched products and the potential unsuitability.
47. As mentioned in Section 3.2, there were 21 samples (7.4%) of 9 banks where the
Sales Reps introduced / recommended the Investment Products before carrying out a risk profile assessment. Instead of inviting these shoppers to complete an RPQ, these Sales Reps usually introduced / recommended the Investment Products either based on (i) shoppers’ background information (e.g. investment objectives, investment experience and / or expected investment return); or (ii) the popularity and performance of the products and / or the lower level of risk involved in the bond funds or RMB bonds.
48. Among these 21 samples, a few Sales Reps subsequently invited the shoppers to
conduct an RPQ and found that the products recommended earlier involved a risk mis-match. However, these Sales Reps did not recommend other Investment Products to the shoppers with due regard to the RPQ assessment results. Instead, the Sales Reps only told the shoppers that investment in risk mis-matched products required management approval and advised the shoppers

the justification (that the shoppers might provide to the banks) for investing in these risk mis-matched products. The Sales Reps did not draw the shoppers’ attention to the risks involved in investing in the risk mis-matched products and explain why these risk mis-matched products were considered suitable for the shoppers (see below for examples). Example 5:
Based on the shopper’s previous investment experiences, the Sales Rep recommended two Investment Products before carrying out a risk profile assessment. The risk profile assessment was subsequently conducted. Upon the shopper’s enquiry for the risk ratings of the recommended products, the Sales Rep replied that she had joined the bank for 3 months and was not familiar with the bank’s system, so she could not retrieve from the system the risk ratings of the recommended products. The Sales Rep then indicated to the shopper that “it does not matter even if your risk tolerance assessment result does not match with the product risk rating, as you would just need to sign-off a risk mis-match acknowledgement afterwards. The most important thing is the performance of the product. Let me show you the performance record.”. The rationale for recommending the two Investment Products was not explained.

Example 6:
After knowing the shopper's expected investment horizon of 3 to 5 years, the Sales Rep recommended two mutual funds (with underlying investments in China market) with product risk ratings of "5" to the shopper before carrying out a client risk profile assessment. Risk profile assessment was subsequently conducted and the resultant client risk tolerance level was "4", which was lower than the risk rating of the two recommended funds (i.e. risk mis-matched products). The Sales Rep only indicated to the shopper that the recommended funds were of higher risks than her risk tolerance assessment result but did not explain the rationale underlying the investment recommendation. Instead, the Sales Rep advised the shopper that the justification (that the shopper may provide to the bank) for investing in the higher risk products could be: “You understand that the China market is volatile but it is your preference”. Given that the shopper did not indicate her preferred investment / market (e.g. China market) to the Sales Rep, the basis for the Sales Rep’s recommendation of the two funds was questionable. Example 7:
The shopper indicated that she was not interested in insurance products. However, the Sales Rep introduced / recommended two mutual funds with the highest product risk rating underlying an ILAS product to the shopper, taking into account the shopper's expected investment horizon of 3 years and expected annual investment return of 10%. The Sales Rep neither invited the shopper to carry out a client risk profile assessment nor mentioned the “insurance” nature of the recommended ILAS during the sales process. The basis for the Sales Rep’s recommendation was questionable. Further, the Sales Reps did not present balanced views and mainly focused on the advantages and good performance of the recommended funds underlying the ILAS product.

Other Observations
49. For a few banks adopting the “portfolio” wealth management approach and
introduced / recommended the risk mis-matched Investment Products to the shoppers, the Sales Reps in some samples did not draw the shoppers’ attention to the risk mis-match and did not advise the shoppers to avoid concentration in the recommended higher risk product(s).

3.5 VULNERABLE CUSTOMERS
50. Among the 350 samples, 144 (41.1%) samples of the 20 banks were conducted
by the vulnerable shoppers. Out of these 144 samples, 62 (43.1%) samples of 18 banks did not involve product recommendations as the Sales Reps declined to introduce / recommend any Investment Products to the vulnerable shoppers either due to unavailability of suitable Investment Products or in view of their old age, education level and / or lack of investment experience and knowledge.
51. Out of the remaining 82 (56.9%) samples involving product recommendations to
the vulnerable shoppers, there were a number of samples where the Sales Reps did not introduce another Sales Rep to the shoppers and / or invite the shoppers to bring along witnesses to confirm the shoppers’ understanding of the product risks and features.
52. Some Sales Reps were not able to identify that the relevant shoppers were
vulnerable (with low education level) because the shoppers’ education level was neither collected in the RPQ nor otherwise enquired by the Sales Reps throughout the sales process.

4. GOOD PRACTICES
53. Good sales practices by Sales Reps were also noted during this exercise. Sales
Reps in general did not introduce / recommend Investment Products of risk ratings higher than the shoppers’ risk tolerance assessment results and / or of risk return profile that did not match with the shoppers’ investment objectives, investment horizon and investment experiences, etc. In samples where the shoppers requested for some Investment Products that were either of risk ratings higher than the shopper’s risk tolerance or assessed to be not suitable for the shoppers by the Sales Reps, the respective Sales Rep highlighted to the particular shopper the following:
(a) The requested products were of higher risk rating than his / her risk tolerance assessment result and drew to the shopper’s attention that the products might not be suitable for him / her in view of the risk mis-match; (b) if the shopper decided on his / her own volition to invest in the product, the shopper should ensure that he / she has sufficient net worth to assume the risks and bear the potential losses of trading in these higher risk products; (c) the shopper was required to provide adequate justification for his / her choice of the products and to sign his / her acknowledgement of the risk mis-match; and (d) the relevant risk mis-matched sales transaction would have to be subject to management approval.
54. In some samples where the shoppers expressed difficulty in understanding the
recommended Investment Products, the Sales Reps further explained the risks and features of the products with the relevant product leaflets to the shoppers and advised the shoppers not to make hasty investment decision.

55. In samples conducted by the elderly shoppers, some Sales Reps proactively
reminded the shoppers to watch out for the high investment risks involved and not to be too “aggressive” even though the shoppers were assessed with the highest risk tolerance after conducting the client risk profiling.

5. WAY FORWARD
56. The SFC has already set out the requirements governing sales practices in the
Code of Conduct 6
, Internal Control Guidelines 7 and the Suitability FAQs 8 .
The HKMA has also issued circulars to banks on supplementary requirements. The HKMA may wish to consider reminding the banks to put in place proper controls and procedures to ensure compliance with the relevant regulatory requirements regarding the selling of Investment Products to investors in Hong Kong.
57. In particular, banks should be reminded to provide their customers with enough
relevant information to make informed investment decisions. Such information would include providing customers with an accurate explanation of product features and risks. Banks should also carry out proper suitability assessments and provide regular training to their sales staff so as to equip them with regularly updated and complete information about the Investment Products they sell and the relevant regulatory guidelines and requirements. Furthermore, banks should perform effective monitoring of the sales process.
58. Regarding the examples and areas of potential non-compliance that have been
highlighted in this report, the HKMA may wish to follow up these with the banks concerned and require the banks in question to take appropriate action to address the issues noted.

Code of Conduct for Persons Licensed by or Registered with the SFC Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the SFC Questions and Answers on Suitability Obligations

59. The HKMA is advised to take into account the experiences and observations
    gained in this exercise when designing similar mystery shopping programmes in the future.