Hong Kong: Changes to Hong Kong’s professional investor rules - a practical insight

Last Updated: 25 September 2011
Article by Richard Mazzochi, Urszula McCormack and Minny Siu

From 16 December 2011, the threshold tests for high net worth professional investors in Hong Kong are likely to become easier.  However, for financial institutions grappling with other regulatory changes affecting those investors, this may provide little comfort.

This alert explains the changes gazetted on 9 September 2011, their practical benefit and how they fit within the broader professional investor framework.

Background - a quick rundown of how the rules work now 

The Securities and Futures (Professional Investor) Rules (Cap 571D) (Professional Investor Rules) supplement the Securities and Futures Ordinance (Cap 571) (SFO), by providing special categories of 'professional investors' who are generally known in the market as "high net worth professional investors". 

In summary, these investors include:

(a) trust corporations, with total assets of not less than HK$40 million or its equivalent in foreign currency;

(b) individuals, either alone or with any associates on a joint account, having a portfolio of not less than HK$8 million or its equivalent in foreign currency;

(c) corporations or partnerships having either a portfolio of not less than HK$8 million or total assets of not less than HK$40 million; or

(d) a corporate investment vehicle that is wholly owned by an individual, who alone or with associates, falls within the description set out at paragraph (b).

High net worth professional investors are able to participate in investment opportunities that are not required to be authorised by the Securities and Futures Commission (SFC) under Part IV of the SFO.   For that purpose, they are treated very similarly to 'institutional' professional investors such as banks and regulated dealers.

However, high net worth professional investors are subject to more onerous accreditation standards (including demonstrating relevant knowledge and experience) than institutional professional investors under the SFC Code of Conduct.  These apply if a financial institution wishes to avoid certain requirements in the SFC Code of Conduct, such as product suitability assessments and mandatory risk disclosures.

What is changing?

Amendments to the Professional Investor Rules were proposed by the SFC late last year, with the aim of achieving greater flexibility and aligning Hong Kong with other leading markets. 

There are two key changes:

1. Any evidence can be used (but there is a catch)

The amending rules allow financial institutions to use "any methods that are appropriate"1  to satisfy themselves that an investor meets the requisite asset or portfolio threshold - not just custodian statements, audited financial statements and third party certificates (Traditional Evidence) that are currently required under the Professional Investor Rules. 

In this respect, they introduce a "principles-based" (rather than prescriptive) approach to determine whether a person qualifies as a high net worth professional investor.

Importantly, while the SFC refused to "bless" self-declarations (that is, a declaration given by the investor that they have the necessary assets or portfolio) during the consultation process, it has equally not ruled them out where the circumstances are appropriate.2

This all sounds like great news for institutions that have been grappling for years with the current Traditional Evidence requirements, which can be onerous and time-consuming.

However, there is a catch. 

The Professional Investor Rules currently allow Traditional Evidence to have been issued some time before the "relevant date" (eg the offer date).  For example, custodian statements can be up to 12 months old.

This is not the case for any other evidentiary method (eg unaudited financial statements, self-declarations, internal checks etc) that an institution may choose to use instead of Traditional Evidence.   This must show that the investor has the requisite assets or portfolio as at the "relevant date".   

One practical upshot is that this change - billed as giving the whole industry more flexibility - will only be capable of being used in practice by a limited number of financial institutions that:

(a) can quickly access information about the relevant investor's assets / portfolio, because they are held with or through that institution; or

(b) are willing to rely on a self-declaration, which carries risks and can be difficult to obtain immediately pre-trade.

There are alternatives - for example, using a self-declaration as at the 'relevant date', coupled with slightly older evidence to offset the risks of relying on that self-declaration alone.  It is also possible to devise very practical mechanisms for obtaining this declaration quickly - for example, agreeing with the client that electronic confirmations are acceptable.3  

2.  More investment vehicles can qualify

It may come as some relief that the second change to the Professional Investor Rules is a lot more straightforward.

The amending rules expand the types of corporate investment vehicles that can qualify as high net worth professional investors.

Currently, they must be wholly owned by an individual who (alone or jointly) has a portfolio of at least HK$8 million. 

The amending rules will allow a corporate investment vehicle also to be owned by other types of high net worth professional investors - that is:

(a) a trust corporation that has assets of at least HK$40 million;

(b) a corporation that has a portfolio of at least HK$8 million or total assets of at least HK$40 million; or

(c) a partnership that has a portfolio of at least HK$8 million or total assets of at least HK$40 million.

In practice, this means that financial institutions can deal more freely with a much broader array of special purpose investment vehicles.  This is important, because those vehicles often do not have an established portfolio or assets that would otherwise qualify them as high net worth professional investors in their own right - they rely on the portfolio and assets of their shareholder(s).

The change also helps level the playing field.  Some financial institutions have been entitled to more flexibility for some time, through bespoke "modifications" granted by the SFC on a case-by-case basis.

Are the changes final?

Technically, no.  The amending instrument is subject to "negative vetting" by the Hong Kong Legislative Council.  It will be tabled for that purpose on 12 October 2011.   However, we do not expect any further changes.

What else is happening with professional investors?

The accreditation requirements for high net worth professional investors under paragraph 15 of the SFC Code of Conduct became more onerous as of 4 June 2011, as foreshadowed in our  May 2011 alert

These standards are relevant to the exemption from certain know-your-client and other requirements under the SFC Code of Conduct.  The standards include:

(a) demonstrating knowledge and expertise, and awareness of the risks involved, in "relevant products and markets"; and

(b) a separate written assessment for each product type and market.  That assessment must be repeated where an investor has ceased to trade in that product or market for > 2 years.

This has already had enormous implications for the Hong Kong financial services industry, with very practical questions regarding this accreditation standard being asked, and many industry players choosing not  to accredit all high net worth professional investors for the purpose of the SFC Code of Conduct (instead, treating them as retail investors and conducting suitability assessments etc).

Industry thinking is continuing to evolve on this issue. 

Next steps

We are already working with a number of our clients on implementing the changes to the SFC Code of Conduct that came into force in June 2011.  These pose the toughest challenges.

We also worked closely with The Hong Kong Association of Banks on the changes to the Professional Investor Rules. 

Please contact us anytime if you would like to discuss the content of this alert, or more specifically:

(a) the implications of using new types of evidence to satisfy the asset / portfolio tests;

(b) how the new categories of professional investors work; or

(c) documenting any aspect of the new professional investor regime.


[1] Paragraph 16, SFC Consultation Conclusions, February 2011.

[2] Paragraph 19, SFC Consultation Conclusions, February 2011.

[3] As with any electronic communication, regulatory information technology requirements and the provisions of the Electronic Transactions Ordinance (Cap 553) should also be considered.

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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