Introduction
On 8 December 2015, the Securities and Futures Commission of Hong Kong (the “SFC”) released the “Consultation Conclusions on the Client Agreement Requirements” (“Consultation Conclusions”), in which the SFC has resolved to proceed with the proposal to require the incorporation of a new clause into client agreements. (The full version of the Consultation Conclusions can be viewed here.) The new clause primarily relates to the requirement for financial products solicited or recommended to be ‘reasonably suitable’ (“Suitability Requirement”) pursuant to the “Code of Conduct for Persons Licensed by or Registered with the SFC” (“Code of Conduct”).

It is advisable for SFC licensed and registered entities, including but not limited to product distributors, fund managers, securities brokers and investment advisers (“Intermediaries”) to be mindful of the Consultation Conclusions and take steps to comply with this additional requirement in the Code of Conduct.

Background
On 25 September 2014, the SFC published Consultation Conclusions on the Proposed Amendments to the Professional Investor Regime and Further Consultation on the Client Agreement Requirements, inviting public comments on the following proposed clause to be incorporated into client agreements:-

“If we [the intermediary] solicit the sale of or recommend any financial product to you [the client], the financial product must be reasonably suitable for you having regard to your financial situation, investment experience and investment objectives. No other provision of this agreement or any other document we may ask you to sign and no statement we may ask you to make derogates from this clause.” (“New Clause”)

There were substantial submissions made on the language of the New Clause, namely (1) wordings in relation to “solicit” and “recommend”, (2) the definition of “financial product”, (3) the standard of “reasonably suitable”, (4) the Intermediaries’ knowledge of clients’ personal circumstances and (5) “non-derogation” component of the New Clause. The SFC’s responses to these comments are set out below:

Wordings in relation to “Solicit” and “Recommend”
It was suggested that the definitions of “solicit” and “recommend” were unclear and broad, and thus these terms should be deleted. The SFC responded in the Consultation Conclusions that these terms are consistent with the Suitability Requirement that Intermediaries are well familiar with as these terms have been used in the Code of Conduct for a number of years. The SFC further stated that given that non-compliance of the Code of Conduct allows the SFC to take disciplinary actions against Intermediaries, the purpose of the incorporation of the New Clause into client agreements is to enable aggrieved investors to directly seek redress against the Intermediaries as a contractual claim for damages. It follows that the New Clause should retain the same main features as in the Suitability Requirement, which include the same trigger for its applicability, namely “solicitation” of the sale and “recommendation” of any financial product to clients.

The Definition of “Financial Product”
The definition of “financial product” is also clarified in the Consultation Conclusion.  Paragraph 6.2(i) of the Code of Conduct will be amended to clarify that the term “financial product” refers to any “securities, futures contracts or leveraged foreign exchange contracts as defined under the Securities and Futures Ordinance (Chapter 571 of the Laws of Hong Kong)”.

The Standard of “Reasonably Suitable”
It was remarked that whether a financial product is “reasonably suitable” is open to varying interpretation. However, the SFC maintained its position that such objective standard would not require further clarification as it would be the usual standard that a court would readily interpret and apply in the prevailing circumstances.

The Intermediaries' knowledge of clients' personal circumstances
In connection with the suggestion that the liability should be premised on the actual knowledge of the clients’ personal circumstances, the SFC in the Consultation Conclusions, referred to the “Know Your Client” requirement in the Code of Conduct where Intermediaries shall take “all reasonable steps” to establish “true and full identity” of clients, and his “financial situation, investment experience and investment objectives”. However, the SFC expressed in the Consultation Conclusions that a client pursuing a claim against an Intermediary will not successfully discharge his burden to establish his case if false or misleading information is provided to the Intermediary and it is not reasonable for the Intermediary to discover as such.

“Non-derogation” component of the New Clause
Some respondents proposed that the non-derogation component be deleted since it does not foster harmonious relationships with clients. However, the SFC considered that the significance of retaining this component is to impose a contractual obligation on Intermediaries not to incorporate disclaimers which defeat the purpose of the New Clause or override other fundamental provisions of the Code of Conduct.

Applicability of the Suitability Requirement into client agreements
It should be noted that all Intermediaries are obliged to include the New Clause in client agreements, as the SFC considered allowing certain specific types of Intermediaries to opt out the New Clause may lead to inconsistent application and unequal protection to investors. However, there are circumstances as set out in the Consultation Conclusions where the incorporation of the New Clause may not be necessary. These are set out below.

i. Pursuant to paragraph 6.4 of the Code of Conduct, client agreements might be limited to the service provided accordingly. It follows that inclusion of the New Clause might not be necessary when an Intermediary acts under a restricted mandate that clearly does not involve soliciting the sale or recommending the financial products.

ii. Under the new professional investor regime to be effective on 25 March 2016, Intermediaries dealing with “Institutional Professional Investors” or “Corporate Professional Investors” have the discretion not to enter into a client agreement. (For more details on the new professional investor regime, please refer to the client alert entitled “SFC Guidance on Corporate Professional Investors Assessment and Description of Services in Client Agreements” which is available here.) The SFC took the view that even if a client agreement is entered into with these professional investors, an Intermediary is not obliged to include the New Clause.

The Way Forward
Following the Consultation Conclusions, the requirement to incorporate the New Clause will be added as 6.2(i) of the Code of Conduct. The SFC will also insert a new paragraph 6.5 to the Code of Conduct, which precludes the incorporation of any clause, provision or term which is inconsistent with obligations of the Code of Conduct or mis-describes the actual services to be provided to clients in the client agreements. The above amendments to the Code of Conduct will come into effect 18 months after the date of releasing the Consultation Conclusions (i.e. 8 June 2017). In light of the tight timeframe, it is advisable for Intermediaries to commence review of their client agreements and ensure that they comply with these new requirements by 8 June 2017.

http://www.klgates.com/sfc-published-the-consultation-conclusions-on-the-client-agreement-requirements-12-22-2015/

JP