Hong Kong: New Proposals to Regulate Mis-Selling of Investment Funds & Structured Products in Hong Kong: Right or Wrong?

Last Updated: 29 January 2009
Article by Timothy Loh, Howard Burchfield III and Gavin Cumming

The recent global financial crisis has resulted in an upswing in regulatory action throughout world markets. In Hong Kong, the Securities and Futures Commission ("SFC") has proposed a slew of new requirements, some of which have already been implemented retroactively and without industry consultation. In this article we examine these ongoing developments in SFC policy and their effectiveness in reaching a fair balance between investor protection and costs to the investor and the financial industry.

The past few months have seen major developments in the approach taken by the Securities and Futures Commission ("SFC") in regulating the sale of investment products, including mutual funds, unit trusts and structured products. The developments continue to crescendo:

  • On October 3, 2008, the SFC issued a circular ("Retail Products Circular") to issuers of retail investment products reminding them of various existing regulatory duties;
  • On December 5, 2008, the SFC issued a letter ("CIS Enhanced Disclosure Letter") to issuers of SFC authorized collective investment schemes providing guidance on marketing materials and, in effect, establishing enhanced disclosure requirements; and
  • On December 31, 2008, the SFC co-authored a Report to the Financial Secretary on Issues Raised by the Lehman Minibonds crisis ("Mis-Selling Report") setting out recommendations for major regulatory changes.

Regrettably, it seems that some of the proposals have already been implemented retroactively by the SFC, in particular those relating to product disclosures set out in the CIS Enhanced Disclosure Letter, without industry consultation and without notice to the industry. As a result, the industry has been forced to review all its marketing materials, including those previously authorized by the SFC, with a view to compliance.

The remaining majority of the proposals have not, however, yet been implemented. Some will require legislative amendments, which will take some time. Others may be effected by changes in SFC regulatory requirements and thus, could be implemented on short notice.

Sales Practices

A major focus for the SFC now appears to be (i) to reinforce and supplement the existing duty of issuers of investment products to provide sufficient, balanced and understandable information to describe the product and its risks, (ii) to reinforce the existing duty of intermediaries selling investment products to ensure the products sold by them are suitable for the investors who purchase them, and (iii) to more proactively enforce existing regulatory duties relating to sales practices.

However, going forward the SFC offers a number of possible proposals for consideration, including:

  • tightening the definition of a "professional investor",
  • requiring disclosure of commissions received by intermediaries,
  • introducing a cooling off period, and
  • introducing new ongoing disclosure requirements for issuers of investment products.

Product Disclosures – Do Investors Read or Understand Them?

In the Mis-Selling Report, the SFC proposes a requirement for summaries to be prepared for all investment products which are offered to the Hong Kong public. These summaries will be no more than 4 pages of plain, concise, easily understood language augmented by charts and diagrams, will include all key information and will facilitate comparison with other products.

These proposals are consistent with regulatory developments in the U.S., the U.K. and Australia and are in fact reflected in the SFC's new authorization and enforcement practices.

In relation to SFC authorized investment funds, the SFC already appears to be implementing the proposal, with the CIS Enhanced Disclosure Letter requiring marketing materials to contain a summary of key product features and risks upfront, prominently and in a few key bullet points. It requires the summary:

  • to state what the product is and what it does, what the key risks are and what the worst case scenario is for an investor, and
  • to remind investors not to invest in the product unless they have been advised by the selling intermediary that the product is suitable.

Content of Product Summaries

Preliminary feedback from the asset management industry suggests confusion as to what is to be included in the summary as opposed to the formal offering document and, consequently, a desire within the industry to standardize the summaries for particular product classes. The industry appears to be experiencing difficulties in describing a product accurately in abbreviated form.

As liability may follow on the occurrence of a risk which was described in the offering document but was not described in the summary because it was considered to be a low risk, there is a concern that issuers of investment products will aim to over-disclose risks in the summary but, because of length constraints, will be forced to generalize risk disclosures to the point where they are all encompassing but meaningless.

Effect of Product Summaries on Investor Behaviour

It is not clear to what extent enhanced product disclosures will benefit investors and whether any such benefit justifies the additional costs of compliance.

In the case of the Lehman Minibonds, whilst a product summary may have highlighted that these products were not traditional fixed income instruments, it is doubtful that such a product summary would have highlighted the bankruptcy of Lehman as a key risk. It is uncertain whether a product summary disclosure highlighting a possible complete loss of principal would have deterred investors as such a loss is possible for virtually every investment product and is likely to be disclosed in all product summaries.

At the same time, investors may not be inclined to read or to take the time and make the effort to understand product disclosures. They may discount written risk disclosures as standardized disclosures without more considered thought.

In this regard, it is possible that at some point, there may be a point of diminishing returns beyond which further risk disclosures may incrementally decrease the effectiveness of individual disclosures. It is not uncommon for investors who have lost money investing to complain that they did not understand a product even after having signed a written declaration that they understood the product.

In any event, it is unclear whether investors are in a position to assess the probability and consequences of disclosed risks materializing. Indeed, many hedge fund managers, regarded as sophisticated investors, failed to successfully assess the counterparty risk of dealing with Lehman Brothers.

The Case Against Product Summaries

It is difficult for product regulations to protect investors in these circumstances. Investment losses, including severe investment losses, are a natural part of investing. In the absence of evidence that investors would modify behaviour appropriately (i.e. to a degree commensurate to the disclosed risks) in light of disclosures contained in marketing materials, there is a danger of over-regulating product disclosures with little investor protection benefits.

Ongoing Disclosure Obligations

In the Mis-Selling Report, the SFC recommends the introduction of statutory requirements for product issuers to provide relevant information to investors including changes in circumstances that may have a significant effect on the value of the investment and for intermediaries to take appropriate steps to ensure that such information is brought to the attention of investors.

The SFC suggests that the SFC website become a central repository for such information in respect of SFC authorized investment products much like the website of the Stock Exchange of Hong Kong is a central repository for such information in respect of listed companies.

The recommendation raises significant potential compliance burdens. Take for example the case of a structured product linked to an underlying listed company and for which the issuing bank serves as counterparty.

  • The bank may issue press releases regularly to disclose material developments which affect its share price and which may be material to the creditworthiness of the bank.
  • The underlying listed company may issue press releases regularly to disclose material developments which affect its share price or creditworthiness.
  • Third parties may produce research which may materially affect the perceived value or creditworthiness of the bank or listed company.

Would the bank now be required to collate, summarize and disseminate information from these press releases and from such research to all intermediaries selling the product?

Alternatively, take for example a mutual fund with a wide ranging portfolio of securities.

  • Is the fund company required to disseminate all public information which may reasonably be available to it in respect of each significant portfolio company as it becomes publicized?
  • Is the fund company required to monitor the custodian bank's creditworthiness on an ongoing basis and disseminate all public information which may reasonably be available to it in respect of the custodian bank which may affect the creditworthiness of the custodian bank as it becomes publicized?

At the same time, would selling intermediaries be required to disseminate such information to clients who purchased the product? Would investors welcome the receipt of such information on a regular basis and would they appreciate the significance of this information?

Suitability – Can Investors Expect Objective Advice For Free?

Many investors rely upon their banker or financial adviser to recommend investment products to them. Consequently, it has been a long standing regulatory requirement that intermediaries must ensure that the advice they provide is suitable for their clients given the clients' individual circumstances.

In the Mis-Selling Report, the SFC proposes to supplement existing suitability obligations by requiring intermediaries:

  • to adopt suitable criteria for characterizing investors with a view to assisting in ensuring that investment advice and products offered are suitable for investors;
  • to ensure products are only sold by staff who have demonstrated a sufficient understanding of the particular product;
  • to document and provide a copy to each client of the rationale underlying the recommendations or solicitations made to the client; and
  • to conduct product due diligence on a continuous basis at appropriate intervals having regard to the nature, features and risks of investment products.

At the same time, the SFC proposes to use undercover enforcement officials as part of a programme to enforce compliance with suitability obligations.

In like vein, in the CIS Enhanced Disclosure Letter, the SFC requires product issuers to place a reminder in the front of their marketing materials that they should not invest in the product unless the intermediary who sells it to them has advised them that the product is suitable and has explained how it is consistent with their investment objectives.

Commercial Realities

At base, any discussion on regulation of sales practices should recognize that selling intermediaries are generally in the business of selling investment products rather than advising clients. This is because clients generally do not pay intermediaries for advice. Rather, product issuers pay intermediaries to distribute products.

Unless the economic interests of selling intermediaries are more closely aligned with the economic interests of their clients, a requirement for selling intermediaries to ensure that product recommendations are suitable may simply encourage intermediaries to justify recommendations in their own economic interests as being suitable for clients rather than to encourage intermediaries to make recommendations based on the economic interests of clients. Reinforcing regulations for selling intermediaries to ensure product recommendations are suitable does not align the economic interests of intermediaries and their clients.

Disclosure of Commissions

Recognizing the possible misalignment of economic interests, in the Mis-Selling Report, the SFC also proposes a requirement for selling intermediaries to disclose at the pre-sale stage commissions payable to and other benefits receivable by them. Such a requirement benefits investors as it places them on notice that the advice which they receive may not be impartial advice. Indeed, the SFC notes that such disclosure is required in Australia, the U.K and Singapore.

Nevertheless, a requirement for disclosure of commissions and benefits does not align the economic interests of selling intermediaries and their clients. Its purpose therefore cannot lie in improving the suitability of advice given but rather with reducing the degree of reliance placed by an investor on advice.

The Extent to Which Disclosures Protect Investors

However, if a misalignment of economic interests persists, it is not difficult to conceive of intermediaries selling products with higher commissions which, whilst not unsuitable, may be less suitable for clients, rather than selling products with lower commissions which may be more suitable for clients.

To take a simplistic example, assume the universe of investment products may be divided into 2 classes, "A" and "B". Intermediaries receive a $5 commission on each unit of "A" sold but only $1 on each unit of "B" sold. In the short term, an intermediary may wish to offer its clients a selection of "A" products, recommending one of them in particular but without offering any "B" products. In this case, a client would not be aware of the "B" products and may consider the commission disclosed to him as not affecting the recommendation given to him to purchase the particular "A" product.

Investor Responsibility

In light of the foregoing, whilst it is clearly beneficial for investors to receive advice that is suitable for them, it is possible that it is counterproductive for the SFC to reinforce suitability obligations on intermediaries as such obligations may perpetuate perceptions amongst investors that advice they receive from intermediaries is premised on their own best economic interests. Instead, it may be more productive for the SFC to encourage investors to pay for financial advice if they wish to obtain investment recommendations which are premised on their own best economic interests. Unfortunately, investors have traditionally shown reluctance to pay for financial advice and it may therefore be desirable for the SFC to consider moving towards a regulatory framework biased towards such an arrangement.

Professional Investors

Broadly, in the Mis-Selling Report, the SFC suggests that there is no general dissatisfaction with the current definition of a "professional investor" under the regulatory framework and thus, by implication, no general dissatisfaction with the circumstances in which investment products may be sold without SFC authorization or without appropriate advice as to suitability. However, the SFC does propose further consultation on the matter as to the necessity of raising the threshold for a person to qualify as a professional investor.

Cooling Off Period

In the Mis-Selling Report, the SFC proposes the introduction of a cooling off period on sale of investment products. It is not clear whether the SFC proposals are limited to products sold to retail investors but presumably this is the case.

Under a cooling off period, investors would have the right to cancel an investment product purchase within a fixed period of time following the purchase. The SFC notes that a cooling off period already exists for Hong Kong insurance contracts, for unlisted unit trusts in Singapore and for certain investment products in the United Kingdom.

The SFC recognizes that in respect of investment products where the value of the investment may fluctuate during the cooling off period, the price refunded on cancellation should be adjusted to reflect any fluctuations.

To the extent that investors are already free to close out any purchase made at any time after the purchase, the proposal does not represent a significant change in current practices and it appears unlikely that such a cooling off period would have been of any assistance to the majority of investors who purchased Lehman Minibonds, as those investors were presumably satisfied with their investment until the collapse of Lehman Brothers.

However, to the extent that investment products are fixed term in nature, the proposal marks a significant change in practice. It effectively eliminates the possibility of an investment product which is premised on a short fixed term, as a product issuer will not be able to effectively hedge the risk it bears on such products, if the investor has the right to withdraw their investment before the fixed term expires.

For products with a longer fixed term, it effectively limits a product issuer from relying upon the initial portion of the fixed term, which may, in turn, affect product structure.

Notably, the SFC does suggest that selling costs associated with cancellation should not be reflected in any adjustment, opening up the possibility (which product issuers must take appropriate steps to guard against) of selling intermediaries defrauding product issuers with fake investment purchases which are cancelled immediately upon receipt of commissions.


Ultimately, investors must assume responsibility for the losses they incur on their investments. Regulation of sales practices, both on product issuers and selling intermediaries, is clearly desirable but at the macro level, the costs, including compliance burdens on issuers and intermediaries and restrictions on product options for investors, must be weighed carefully against investor protection benefits.

The limits of regulation should also be realistically appraised. To some degree, the SFC must allow investors to suffer the consequences of their own action where they have failed to use the regulatory protections and financial product information which is already available to facilitate their investment-making decisions. In this regard, the SFC should be wary of allowing a climate of heightened regulation to lure investors into the mistaken belief that it and other regulatory authorities exist primarily as a means to insure them against the results of their own folly.

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .


    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions