Hong Kong regulator has introduced stringent suitability rules on the sale of investment products by online distribution and advisory platforms, which include robo advisors.
Following a consultation that began in May 2017, the Securities and Futures Commission (SFC) will gazette the final guidelines on 6 April, giving intermediaries and other related parties 12 months to set up internal processes and systems.
Online advisory and distribution platforms will now have to be licenced or registered if their Hong Kong business amounts to regulated activity.
The guidelines also lay out the requirements for platform operators to ensure the suitability of the sale of non-complex and complex products to clients, similar to rules applied to private banks and other intermediaries.
These requirements are listed out in Hong Kong’s Code of Conduct for Persons Licensed or Registered with the SFC, who are required to ensure the suitability of a recommendation or solicitation for a client in all circumstances, based on information provided during client on-boarding and Know-Your-Customer checks.
Commenting on the guidelines, SFC CEO Ashley Alder said: ‘They allow more flexibility for investors to manage their investments online, whilst providing them with additional protection in relation to complex products whose features and risks retail investors may have difficulty in fully understanding.’
Complex products refer to products with structures, risks and features that are not likely to be understood by retail investors. For example, the SFC deems futures contracts traded on the Hong Kong Futures Exchange, equity derivatives, leveraged and inverse ETFs, certain fund structures and bonds with special features as complex.
Listing out the guidelines in a 76-page document, the SFC introduced multiple requirements on disclosure and risk assessment, among other areas.
Online platforms will have to provide information on how the risk ratings for investment products were determined in an easily comprehensible manner. The SFC has also aligned the requirements to disclose remuneration information for the platforms with existing disclosure requirements in Hong Kong.
Since the suitability requirement is triggered by a solicitation or recommendation, due to its very nature, robo advisory would need to adhere to the new guidelines. Such platforms will also have to accurately describe services.
‘For example, where a robo-adviser provides goals-based advice such as planning for children’s education, it should not describe its services as providing comprehensive financial planning,’ the SFC said in the consultation conclusions published on its website.
Additionally, platforms will have to inform clients of the scope and limitations of services. Robo advisers will have to put in place controls to detect algorithmic failures and halt trading if necessary.
They are also expected to have a ‘suitably-qualified person’ to test and review the algorithm used to generate investment advice, and inform clients of how and when the algorithm will rebalance the portfolio.
The SFC clarified that the guidelines only apply to client-facing technology tools. Intermediaries, such as private banks, are however required to conduct due diligence on service providers for non-client-facing technology.
The regulator has proposed to apply the same requirement to ensure suitability to the offline sale of complex products to avoid regulatory arbitrage, and has commenced a two-month consultation on this proposal.