The Guidelines on Online Distribution and Advisory Platforms (Guidelines) issued by the Hong Kong Securities and Futures Commission (SFC) will become effective on 6 July 2019. With the recent expansion of various online financial platforms, the SFC began a public consultation in mid-2017 to introduce guidelines applicable to all SFC-licensed or registered persons when conducting their regulated activities via online distribution and advisory platforms for investment products targeting Hong Kong investors (Online Platform Operators). The Guidelines provide advice to the industry regarding the design and operation of platforms, and clarify the applicability of the Suitability Requirement (as described below) and other existing regulatory requirements.

The Guidelines focus on four major aspects: the Suitability Requirement; additional protective measures for the sale of complex products on online platforms; governance and controls; and robo-advice.

The Suitability Requirement

The Suitability Requirement provides that, when making a recommendation or solicitation to a client, a licensed or registered person should ensure that the suitability of the recommendation or solicitation is reasonable in all circumstances, having regard to information about the client of which the licensed or registered person is or should be aware through due diligence.¹

The Suitability Requirement will be triggered when an Online Platform Operator posts materials that are deemed to be solicitations or recommendations. This determination is a question of fact, and the SFC will assess the content and context of the materials, together with the design and overall impression created by the platform content. The SFC has provided a non-exhaustive list of examples of situations that may, or may not, trigger the Suitability Requirement.²

In instances where the Suitability Requirement is triggered, Online Platform Operators must comply with the standards of the existing requirements in the Code of Conduct, which include that such entities: must perform product due diligence; conduct know-your-client processes; and match the risk/return profile of the investment product selected by a client with the client’s personal circumstances (e.g., investment objectives, investment knowledge and experience, risk tolerance, portfolio concentration risk,³ and financial situation). Risk profiles of investment products should be regularly reviewed. Where an Online Platform Operator assesses a transaction as unsuitable for a client but the client nevertheless wishes to engage in the transaction, the Online Platform Operator should not proceed to effect the transaction.

Additional Protective Measures for the Sale of Complex Products on Online Platforms

In instances where a financial product is sold on an online platform and no recommendation or solicitation is made to clients, the Guidelines provide that such a product must be classified as either a complex product or a non-complex product. If such product is a classified as complex, the Suitability Requirement will apply.

In determining whether to classify a product as complex or non-complex, the SFC provided further guidance in the form of frequently answered questions on the Guidelines (FAQs).

Classification

General

The classification of investment products as complex or non-complex focuses on whether the terms, features and risks of a product are too complex for a retail investor to understand. Factors to be considered include whether:

• The product is a derivative instrument;
• A secondary market exists for the product at publicly available prices;
• There is adequate and transparent information about the product;
• There is a risk of losing more than the amount invested;
• Any features or terms of the product could fundamentally alter its nature, risk or pay-out profile, or include multiple variables or complicated formulas to determine its return; and
• The product is illiquid and/or difficult to value.

An Online Platform Operator should use due skill, care and diligence in its determination of whether a product is treated as complex or non-complex. However, it is not expected to perform detailed calculations regarding a fund’s allocation to each underlying investment.

Funds

In respect of SFC-authorized funds, Online Platform Operators are required only to assess whether the fund is a derivative fund or a non-derivative fund. In making this determination, Online Platform Operators should consider whether the purpose and use of derivatives by the fund is comparable to the SFC’s regime under the Code on Unit Trusts and Mutual Funds (UT Code).

SFC-authorized non-derivative funds under the UT Code (which have net derivative exposure of up to 50% of the fund’s NAV)⁴ are non-complex products.

With respect to funds other than SFC-authorized funds,⁵ Online Platform Operators should first assess whether the fund is a derivative or non-derivative fund:

• Derivative fund: A derivative fund, whether listed or unlisted, is a complex product. If a derivative fund is listed in a Specified Jurisdiction (as set out on the website of SFC),⁶ an Online Platform Operator is not required to comply with certain requirements applicable to complex products.⁷ If the fund is listed in other than a Specified Jurisdiction, the Online Platform Operator should exercise caution in determining whether the fund can be treated on the same basis as funds listed in a Specified Jurisdiction – if so, it is not necessary to comply with those requirements.

• Non-derivative fund: If the fund is a non-derivative fund, an Online Platform Operator should take further steps to ascertain: (1) whether the fund is authorized or approved to be offered to retail investors by an overseas regulator; and if so (2) whether the overseas public fund is regulated by or traded on an exchange in a Specified Jurisdiction. If the fund is regulated by or traded on an exchange in a jurisdiction that is not a Specified Jurisdiction, further caution should be exercised. An Online Platform Operator should consider (among other things): the structure and strategy of the fund; and the nature of underlying investments for purposes of the product disclosure documents. However, the Online Platform Operator is not required to perform detailed calculations regarding the fund’s allocation to each underlying investment. A non-derivative fund that fulfills criteria (1) and (2) is likely a non-complex product. A non-public non-derivative fund is likely a complex product, having regard to the factors set out above (including availability of information about the fund and liquidity in the secondary market).

Complex Products Requirements

The Guidelines require Online Platform Operators to ensure that any transaction in a complex product is suitable for the client under all of the circumstances, regardless of whether any recommendation or solicitation is made concerning the product. In respect of complex products that are also derivative products traded on an exchange in Hong Kong, or in a Specified Jurisdiction in instances where there has been no solicitation or recommendation, an Online Platform Operator is not required to comply with the Suitability Requirement for transactions in such products executed on an exchange.⁸ In respect of derivative products traded on an exchange that is not in a Specified Jurisdiction, an Online Platform Operator should comply with the Suitability Requirement, unless such products could reasonably be treated on the same basis as derivative products traded on an exchange in Hong Kong or in a Specified Jurisdiction.

Online Platform Operators should ensure that their platforms provide: sufficient information regarding the key nature, features and risks of complex products; and prominent and clear warning statements regarding complex products before, and reasonably proximate to, the point of sale or advice.

Online Platform Operators dealing with Institutional Professional Investors (as defined in the Code of Conduct) are exempted from the above requirements pertaining to complex products.⁹

Governance and Controls

The Guidelines set out six core principles with which Online Platform Operators should comply, indicating that such entities should:

• Ensure that the platform is properly designed and operated in compliance with all applicable laws and regulations. This includes putting in place appropriate access rights and controls, so that the public (including retail clients) would not be able to access materials in breach of the Companies (Winding Up and Miscellaneous Provisions) Ordinance or requirements under Part IV of the Securities and Futures Ordinance (in connection with the offering of investments);
• Make clear and adequate disclosure of relevant material information regarding the platform, including up-to-date product offering information and contact details for client enquiries and complaints. Where selected lists of investment products are posted on the platform, the Online Platform Operator should disclose the objective criteria by which such investment products are selected;
• Ensure the platform’s reliability and security (e.g., data protection and cybersecurity);
• Implement robust governance arrangements and conduct regular reviews of internal operational policies;
• Perform ongoing reviews of all activities conducted on the platform; and
• Maintain proper records, including documentation on the platform’s design, operations, modifications, tests and reviews, as well as audit trails of activities.

Robo-advice

Robo-advice can be provided in various forms, including: (i) fully-automated without human intervention; (ii) adviser-assisted, where the platform provides clients an option to contact an adviser; or (iii) guided, where investment advice is given by an adviser assisted and supported by technology tools. The SFC has provided the following guidance for Online Platform Operators that furnish investment advice directly to clients in an online environment via direct use of technology tools by the clients (client-facing tools):

• Robo-advisers should provide sufficient information on their online platform(s) and continuously disclose clear and adequate material information, including information on the limitations and risks of their services and the degree of human involvement.
• Client profiling tools and/or questionnaires should be designed to obtain suitable advice based on the clients’ personal circumstances.
• Robo-advisers should supervise the design, development, deployment and operation of algorithms used in digital advice tools. They also should supervise the operation and testing of the algorithms that form the basis of any investment advice provided. There should be adequate staff with sufficient expertise and understanding of the technology, who are provided with adequate training and testing.
• Where algorithms are used to automatically rebalance a pre-defined model portfolio to maintain a target asset allocation over time, robo-advisers should inform clients of: the existence of such automatic portfolio balancing; major changes to the algorithms; and the mechanics of the rebalancing. If clients are offered the ability to opt-out of rebalancing, they should acknowledge and agree to the change in scope and terms of services and be informed of the potential risks and consequences.

If client-facing tools are not involved, Online Platform Operators should comply with other applicable requirements (e.g., the Code of Conduct) and the FAQs. Whether or not an Online Platform Operator is providing advice on a discretionary basis, it should comply with the Suitability Requirement.

Footnotes

1) The Suitability Requirement is set out in paragraph 5.2 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Code of Conduct).

2) For example, posting lists of investment products selected using objective criteria such as performance data would not trigger the requirement; however, presenting a specific list of investment products with an accompanying statement such as “these products may suit you or match your risk tolerance level” to clients immediately after risk-profiling would trigger the requirement.

3) Concentration risk refers to the risk that a client's assets available for investment are overly exposed to the same set of risks. This risk should be assessed based on available information about the client, including the client's risk tolerance level. SFC-licensed or registered persons may recommend a high-risk product to a low- or medium-risk-tolerant client, provided that the product is commensurate with the risk return profile of the entire portfolio of the client and meets the investment objectives and other personal circumstances of the client.

4) This is defined under the UT Code effective on 1 January 2019, subject to transition arrangements ending on 31 December 2019.

5) The SFC has produced a flowchart illustrating how to determine whether or not a fund that is not an authorized fund is a complex product.

6) The list of Specified Jurisdictions, which the SFC updates from time to time, is available at https://www.sfc.hk/web/EN/rules-and-standards/suitability-requirement/non-exhaustive-list-of-examples-of-non-complex-and-complex-products/list-of-specified-jurisdictions.html.

7) The requirements that need not be complied with are paragraphs 6.3, 6.7 and 6.8 of the Guidelines.

8) In this case, the Online Platform Operators must still comply with the requirements under paragraph 5.1A and 5.3 of the Code of Conduct.

9) Further, Online Platform Operators dealing with Corporate Professional Investors (as defined in the Code of Conduct) may also be exempt, by complying with the requirements and procedures set out in paragraphs 15.3A and 15.3B of the Code of Conduct.