Article by Angelyn Lim, Kher Sheng Lee and Carmen Cheng

The Hong Kong Securities and Futures Commission ("SFC") has announced landmark proposals to overhaul the existing regulatory framework for unlisted investment products in a bid to further safeguard investor interests.

Introduction and Background

In its Consultation Paper on Proposals to Enhance Protection for the Investing Public1 (the "Consultation Paper") issued on 25 September 2009, the SFC has published wide-ranging proposals to address some of the perceived short-comings in the current regulatory environment for the sale of unlisted investment products to the public.

The proposals were formulated in the aftermath of heavy investor losses from failed investments in certain retail structured products (generically referred to in the media as "Minibonds") triggered by the collapse of Lehman Brothers in September 2008 and the subsequent global financial crisis.2 As a result, the proposed reforms impact all stages of the investment process from an investor's perspective, from the pre-sale stage (with proposed requirements for product documentation and the codification of advertising guidelines) to the sales stage (with enhanced scrutiny on intermediaries' distribution processes and conduct during the actual sale to prospective investors, and proposed requirements for disclosure of commissions received), to post-sale arrangements (requiring continued disclosure by product issuers and the proposed introduction of a "cooling-off" period in respect of some products). These proposals are discussed in further detail below.

The proposed SFC Handbook for Unit Trusts and Mutual Funds, Investment-Linked Assurance Schemes and Unlisted Structured Products will, for the first time, codify in one document the different codes of practice governing the structure and offering of unlisted investment products to the retail public, consistent with the approach adopted in other jurisdictions with a comparable regulatory regime, such as the UK, Australia and Singapore. Excluded from the scope of the Consultation Paper are real estate investment trusts, listed structured products, mandatory provident fund schemes, pooled retirement fund schemes and immigration-linked investment schemes, all of which are governed by existing legislation or codes of practice.

In addition, there is a separate consultation planned to consolidate the existing Companies Ordinance3—which currently governs offering documentation requirements for structured products—into the regime under Part IV (Offers of Investments) of the Securities and Futures Ordinance,4 a move that will reinforce a consistent approach to regulating the offering of retail products in Hong Kong. There are also additional consultations (all targeted to take place by the end of this year) planned to (i) bolster investor education (which was found to have been very much lacking during the Minibond scandal); and (ii) establish a Financial Ombudsman.


In summary, the scope of the Consultation Paper is set out below:


(Source: Hong Kong Securities and Futures Commission)

Following are the key aspects of the proposals.

Products: Pre-Sale Documentation

The purpose of these proposals is to clarify and ensure a consistent application of documentation standards and common principles to all unlisted retail investment products. Criteria that the SFC will normally consider in authorizing offering documentation and advertisements relating to a retail product will be consolidated into the SFC Handbook (see Consultation Paper Part II).

The new SFC Handbook will comprise:

  • a new Code on Unlisted Structured Products (the "SP Code") (see Consultation Paper Part II, Section 1, page 24);
  • a revision to the existing Code on Unit Trusts and Mutual Funds (the "UT Code") (see Consultation Paper Part II, Section 2, page 41); and
  • a revision to the existing Code on Investment-Linked Assurance Schemes (the "ILAS Code") (see Consultation Paper Part II, Section 3, page 56).

A consistent requirement across all three codes is the product Key Facts Statement ("Product KFS") that will form part of the offering document, and is to be in short form (ideally no more than four pages long) and drafted in user-friendly language. Key principles have been set out in the Handbook as well as sample templates. Information to be covered in the Product KFS includes the name of the management company, the investment strategy of the relevant product, key risks, asset allocation and fees and charges payable.

New SP Code

The new SP Code seeks to provide a flexible regulatory framework within which unlisted structured products may be offered to the public in Hong Kong. To enhance transparency in (i) product infrastructure and maintenance; (ii) the appointment of parties playing key roles in respect of a structured product; and (iii) matters such as valuation of the product from manufacture through to maturity, the following have been proposed:

  • eligibility requirements for issuers, guarantors and reference assets (to which a structured product is linked) of products;
  • where the issuer is a special purpose vehicle, additional safeguards in the form of structural and eligibility requirements;
  • a category of service provider called the "product arranger" who would be a Hong Kong-licensed entity answerable to the SFC for certain administrative matters and ongoing regulatory compliance in relation to the relevant structured product; and
  • in relation to collateralized structured products, additional collateral criteria.

Revised UT Code

The proposed revisions to the existing UT Code seek to:

  • modernize the regulatory framework for SFC-authorized schemes and broaden the scope for product development, in response to developments in the financial markets, regulatory changes in major overseas funds jurisdictions, and new product proposals presented to the SFC by industry practitioners;
  • provide a broadly level playing field between UCITS III schemes and non-UCITS schemes; and
  • codify regulatory principles for structured funds and provide increased flexibility for retail funds to invest concurrently in collective investment schemes and other financial instruments.

These suggested revisions are elaborated upon below.

Key proposals to modernize the regulatory framework of the UT Code include the following:

  • "structured funds" will be added as a type of "specialized scheme" with specific authorization requirements, which will be set out separately in the revised UT Code as a new Chapter 8.8;
  • annual reports will be required to be published in both English and Chinese for SFC-authorized schemes that are not "recognized jurisdiction schemes"5 and that have Hong Kong investors;
  • a Product KFS will be required to be produced for each single fund, or for each sub-fund of an umbrella fund;
  • the current 50% value restriction for connected party transactions will be replaced by general principles, such as arm's-length terms, fees and commissions to be capped at prevailing market rate, and disclosure of benefits in the annual report; and
  • performance fees may be calculated on more flexible bases than is currently permitted (e.g., they may be calculated with reference to the performance of a benchmark or an asset class), which is likely to be welcomed by industry participants.

To level the playing field with UCITS III schemes:

  • SFC-authorized non-UCITS schemes will have the flexibility to invest in financial derivative investments ("FDI") for investment purposes, in the same way that UCITS III schemes may, with exposure thresholds in line with those applicable under the UCITS III regime.

To provide increased flexibility for retail funds to invest in other schemes:

  • A retail fund may (i) invest up to 10% of its net asset value ("NAV") in non-recognized jurisdiction schemes; (ii) invest in one or more SFC-authorized schemes or recognized jurisdiction schemes provided that no more than 30% of its NAV may be invested in any one of these schemes; and/or (iii) invest more than 30% of its NAV in an SFC-authorized scheme (but not a recognized jurisdiction scheme).

Revised ILAS Code

The ILAS Code is proposed to be revised to codify existing practices, enhance disclosure in the offering documents of ILAS and implement the key recommendations on investment products made in the SFC's report to the Financial Secretary in December 2008. Apart from the Product KFS, other key proposals include:

  • deleting the existing chapters in the current ILAS Code dealing with (i) appointment of a Hong Kong representative, (ii) Broker Managed Funds, and (iii) Investment-linked Savings Plans; and
  • codifying the practice that non-guaranteed returns will not be taken into account for the computation of surrender values.

Conduct by Intermediaries: Sales Process and Disclosure

The Consultation Paper proposes to revise the Code of Conduct for Persons Licensed by, and Registered with, the SFC, as well as the Securities and Futures (Professional Investor) Rules, both of which have come under heavier regulatory scrutiny in the recent past. Key proposals, and the rationale for such proposed revisions, are set out below:

  • Sales disclosure document. To regulate intermediary conduct and distribution practices in the sale of investment products in Hong Kong (given that the Hong Kong regulatory regime for the sale of investment products rests on the two important principles of disclosure of product information and suitability of the product for the investor), certain information will be required in the sales disclosure document, including (i) the capacity (whether as principal or agent) in which an intermediary is acting; (ii) the affiliation (if any) of the intermediary with the product issuer; (iii) disclosure of monetary and non-monetary benefits paid or payable to the intermediary; and (iv) the terms and conditions under which an investor may receive a discount of fees and charges from an intermediary.
  • Investor characterization. To reinforce the point that asset thresholds and portfolio size are not, per se, sufficient indicators of a "professional investor" status, intermediaries will be required, as part of the "Know Your Client" process, to seek from clients, information in relation to each client's knowledge of derivatives. Unlisted derivative products may only be promoted to investors with "knowledge of derivatives". Also, the term "professional investor" will be redefined to include only those investors with sufficient knowledge, expertise and investment experience in the relevant financial products, as well as having an investment portfolio of an appropriate size.
  • Pre-sale disclosure of benefits. To address potential intermediary conflict of interests issues regarding benefits received, intermediaries must make disclosure to the prospective investors of both monetary and non-monetary benefits received by the intermediary from the issuer (or others).
  • Prohibition of use of gifts. To prevent unsophisticated investors from being distracted by gift incentives from intermediaries without paying sufficient attention to the features of the investment product, intermediaries will be prohibited from using gifts in promoting any specific investment product.
  • Audio recording. To ensure that a clear record of the relevant processes is undertaken in case of future dispute, the financial services industry is being consulted as to whether audio recording of the client risk profiling process and the advisory or selling process for investment products should be made mandatory.

Post-Sale Arrangements

Cooling-Off Period

The SFC has proposed the introduction of a cooling-off period, in order to provide investors in long-term investments for which there is no ready secondary market, an opportunity to change their minds within a short period after the initial investment decision. During this period (ranging from 2–21 (or more) days), it is proposed that investors in such products be able to exit the investment or cancel the order, and receive a refund of capital and related commission, subject to a reasonable administrative charge and any legitimate market value adjustment.

Continued Disclosure

Proposals are included for issuers (particularly those of structured products) to provide investors with information on an ongoing basis, post-investment, including financial updates and any material adverse changes affecting the issuer, and (in the case of structured products) regular indicative valuations of the relevant product.

Inevitable Reform: The Way Forward

The SFC noted in the Consultation Paper that, post-Minibonds, "it is not possible to consider returning to business as usual and intermediaries must recognize the need for enhancement of the regulatory environment in which they sell investments to the public . . . [w]e urge respondents to focus on what is the right answer in the context of recent events and then to consider how to implement the necessary changes". (emphasis added)

Our recommendation would be for intermediaries to establish internal cross-functional teams with representation from all relevant divisions (including the legal, compliance, risk management, product, business development and marketing teams) to identify points of concern and coordinate a coherent response to the proposals. It may also be timely to commence the necessary groundwork for an appropriate implementation plan—we believe that most of the proposals are likely to be adopted in one form or another. At least in part a reaction to the events surrounding the Minibond saga, it is now widely accepted that enhanced regulation in Hong Kong of the offer of retail investment products is inevitable. This is consistent with general regulatory developments and trends in other parts of the world, particularly the United States and Europe.

The consultation period for the proposals ends on 31 December 2009. It is likely that the Consultation Conclusions will be available sometime in the first quarter of 2010.


The proposals will have significant implications for both issuers and distributors of most investment products that are offered to the public in Hong Kong. They also require serious consideration by any asset manager (including overseas-based managers) considering accessing the investing public in Hong Kong, either directly or indirectly via sub-investment management mandates for collective investment schemes that are offered to the Hong Kong public. We will, in subsequent publications or events, comment on issues that warrant more detailed discussion.


1 Available at

2 For a more detailed discussion of the Minibond saga and related developments, please refer to _1_01_09_Hong_Kong_Securities.pdf, Services Report - 03_09.pdf and

3 Cap. 32, Laws of Hong Kong.

4 Cap. 571, Laws of Hong Kong.

5 "Recognized jurisdiction schemes" are schemes listed in Appendix A1 to the existing UT Code (currently schemes domiciled in France, Germany, Guernsey, Ireland, the Isle of Man, Jersey, Luxembourg, the UK and the United States).

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.