China: Tightening The Reins – Promulgation Of The Administrative Measures On Suitability For Securities And Futures Investors

Last Updated: 25 January 2017
Article by Qing Xie and Brigitte Lu

On December 15, 2016, the Administrative Measures on Suitability for Securities and Futures Investors ("Measures") were officially promulgated. As outlined by the China Securities Regulatory Commission ("CSRC") in the drafting statement, the regulators' main considerations in crafting the Measures were: first, the current rules on suitability administration are fragmented, mentioned throughout the rules governing various businesses, and the requirements of the duty of suitability thereunder are unclear, therefore, it is necessary to formulate a uniform administrative regulation; second, both the investors and operational institutions of the current market are still immature whilst the regulatory rules and mechanisms are yet to be gradually improved, so strengthening the administration on suitability will help to enhance the regulation of the innovations driven by the market and prevent any systematic risk; third, by enhancing the responsibility of operational institutions, it may effectively transmit the regulatory requirements and pressure to the front-line operational institutions. In our view, these three considerations reflect how painstakingly and comprehensively the content of the Measures has been crafted – increasing requirements for the operational institutions and with the promulgation of the Measures possibly increasing their burden of compliance. However, its emphasis on protecting the interests of investors may benefit the healthy development of the industry in the long run. The Measures will take effect on July 1, 2017, and there are about six months remaining for the relevant operational institutions to take steps to prepare.

Scope of Application

The scope of application of the Measures covers: in the sale to investors of the (i) securities which are publicly or privately offered, (ii) securities investment funds or equity investment funds which are publicly or privately raised, (iii) futures or other derivative products which can be publicly or privately transferred, or providing investors with the relevant services, such as the asset management services, product distribution services or brokerage services. All providers offering securities and futures products or services to investors ("Operational Institutions"), including the private fund managers and the distribution agencies of the above financial products, are subject to the provisions of the Measures.

Four Steps

The Measures provide that the Operational Institutions shall act diligently and perform their duties prudently in the course of distributing products or providing services, and carry out the following four steps:

  1. KYC: Apart from the basic information of an investor, an Operational Institution shall understand the financial status, investment experience, investment goals, risk preference and tolerable loss of each investor, as well as its credit record, any natural person who has de facto control over the investor and any de facto beneficiary who can benefit from the relevant transaction.
  2. Risk assessment and disclosure: An Operational Institution shall conduct a thorough investigation and analysis of the relevant product or service and classify the different levels of risk for the product or service. An Operational Institution shall not offer an assessment of risk lower than the risk assessment of the industrial product or service formulated by the relevant industrial association.
  3. Provide an opinion on suitability matching: An Operational Institution shall, based on the risk tolerance capacity of each investor, the level of risk of the relevant product or service and other factors, provide its opinion on suitability matching, and such opinion shall be definite and clear. The opinion on suitability matching includes two aspects: an Operational Institution shall first decide the suitable type of investors according to the level of risk of a product or service, and then it shall decide the relevant product or service suitable to a single investor based on the classification of such investor.
  4. Sale of product: An Operation Institution shall provide its opinion on suitability matching to each investor, and ensure that it will sell or provide a suitable product or service to such investor.

Classification of Investors

The Measures divide the investors into ordinary investors and professional investors, and specify the scope of the professional ones. Five types of professional investors are outlined in the Measures, including the licensed financial institutions, subsidiaries of financial institutions registered with the relevant industrial associations, private fund managers or any product issued by the foregoing institutions, QFII or RQFII etc.. A legal person may be deemed a professional investor if at the end of the previous year its net asset was not lower than RMB 20 million, or at the end of the previous year its financial asset was not lower than RMB 10 million while having investment experiences in securities, funds, futures, gold or foreign exchange for over two years. Meanwhile, a natural person with personal financial assets not lower than RMB 5 million or with annual personal income not lower than RMB 0.5 million for the previous consecutive three years may satisfy the asset threshold for professional investor. Any legal person or natural person deemed a professional investor by the Measures may choose to become an ordinary investor by notifying the Operational Institution in writing. However, the Operational Institution may at its discretion decide whether to agree to such conversion.

Special Protections for Ordinary Investors

As provided by the Measures, ordinary investors are entitled to special protections in terms of information disclosure, risk warning, suitability matching: for information disclosure and risk warning, the necessary information to be provided by an Operational Institution includes any matter which may directly lead to any loss of the principal amount, any change of the business or financial status of such institution, and any material event which may impact the judgment of the investor. Meanwhile, the Measures require the Operational Institution to bear the duty of special attention when selling a high-risk product or service to an ordinary investor; for suitability matching, no Operational Institution shall actively recommend any product or service to an ordinary investor which does not match its investment goal or the level of risk of which is beyond the investor's risk tolerance capacity. With respect to ordinary investors, an Operational Institution shall make careful assessments and manage them accordingly. All of which indicates that the cost of an Operational Institution to sell a high-risk product to an ordinary investor has significantly increased, and so has the risk of being sued for misconduct.

Internal Administrative System of Suitability

In addition, the Measures require the Operational Institution to set up an internal administrative system of suitability, and to set up and promptly update the database for investor assessment, and it shall not adopt any incentive measures for performance which may encourage inappropriate sales.

Self-Inspection and Preservation of Documents

Any Operational Institution shall conduct the self-inspection for suitability on a semiannual basis. The minimum requirement for the term of an Operational Institution to preserve the information and material in relation to its performance of duty of suitability shall be 20 years.

Third Party Distribution

When selecting a distribution agency, it is necessary for an Operational Institution to confirm that the distribution agency is capable of performing the duty of suitability, and shall inform the distribution agency of the criteria and requirements for the suitability management of the relevant product, which shall be implemented by the agency, unless otherwise provided by law, administrative regulation or other rules of the CSRC. If an Operational Institution distributes products on behalf of others, it shall not only set forth the relevant information to be provided by the entrusting party in the distribution agency contract, including the factors considered for product rating, but also itself investigate and verify such information provided by the entrusting party.

Regulatory Function

The Measures provide the supervisory power of the CSRC and its dispatched offices as well as the self-disciplinary administration function of the exchanges, the depository and clearing institutions and the industrial associations. The CSRC and the self-disciplinary organizations may provide further requirements on the admission of investors in relation to any specific market, product or service.

Reversion of the Burden of Proof

The Measures specify that the reversion of the burden of proof will be carried out in the event of any dispute between an Operational Institution and an ordinary investor. That is, the Operational Institution shall bear the burden of proof to provide evidence that it has performed the duty of suitability for investors. On condition that such duty has been fulfilled by the Operational Institution, an investor shall bear its own liability if any information it provided turns to be false, incorrect, incomplete, or it fails to immediately notify the Operational Institution of any material change of the information it previously provided.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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