On 22 January 2015, the Securities and Futures Commission of Hong Kong (SFC) issued a set of frequently asked questions to provide practical guidance on the criteria and application of the new principles based assessment for corporate professional investors (CPI Assessment), and the description of services to be included in client agreements as required under paragraph 6.2(d) of the Code of Conduct (FAQ).

Financial intermediaries, such as product distributors, fund managers, securities brokers and investment advisers (Intermediaries), should be mindful of the guidance set out in the FAQ and take it into account in client on-boarding procedures and client agreements.

Background
The SFC previously issued the Consultation Conclusions on the Proposed Amendments to the Professional Investor Regime and Further Consultation on the Client Agreement Requirements on 25 September 2014 (Consultation Conclusions). Under the Consultation Conclusions, a new paragraph 15 of the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Code of Conduct) will come into effect on 25 March 2016, under which corporate professional investors will be subject to the CPI Assessment before certain requirements under the Code of Conduct can be waived. In addition, the Consultation Conclusions provided that paragraph 6.2(d) of the Code of Conduct (relating to description of actual services to be provided by Intermediaries in client agreements) would not be amended, and that the SFC would provide further guidance as to its application.

On 22 January 2015, the SFC issued the FAQ to provide practical guidance on the CPI Assessment, and the application of paragraph 6.2(d) of the Code of Conduct. Below is a summary of the key points in the FAQ.

CPI Assessment
Under the new paragraph 15 of the Code of Conduct (coming into effect on 26 March 2016), Intermediaries will be subject to the CPI Assessment, which is a set of new principles based assessment criteria as set out under the new paragraph 15.3A of the Code of Conduct, when dealing with CPIs, before they can waive compliance with certain investor protection provisions under the Code of Conduct.

The CPI Assessment takes a holistic, principles based approach in determining whether a CPI has the appropriate corporate structure, and investment process and controls. It replaces the current bright-line tests, which includes assessment of the investment experience of, and the frequency and size of trades carried out by, the CPI.

Assessment Criteria
The CPI Assessment involves the assessment of:

• whether the CPI has the appropriate corporate structure and investment process and controls
• whether the person(s) responsible for making investment decisions on behalf of the CPI has(have) sufficient investment background
• whether the CPI is aware of the risks involved, to be considered in terms of the person(s) responsible for making investment decisions.

Practical Considerations
In the FAQ, the SFC sets out the following practical considerations as guidance for Intermediaries to determine whether the CPI Assessment has been appropriately conducted:

(a) An Intermediary should exercise professional judgment to classify products and markets into different categories (by taking into account the nature, features and risks of such products and markets), and apply the relevant classification to the CPI.

(b) In considering whether a CPI would be more likely to be regarded as having an "appropriate corporate structure" and substantive "investment process and investment controls", an Intermediary should consider whether it:

(i) has an in-house treasury, investment or similar function comprising of competent and suitably qualified professionals responsible for its investment strategies and process

(ii) has an investment committee comprising of competent and suitably qualified professionals responsible for its investment strategies and process

(iii) engages an external investment advisory team comprising of competent and suitably qualified professionals responsible for its investment strategies and process, and this external team is: (1) independent of the Intermediary; (2) subject to regulatory oversight (if required); and (3) serving in the capacity of an investment advisory to the Corporate Professional Investor

(iv) relies on and follows the investment strategies, advice and recommendations of its related corporation, provided that the related corporation is able to comply with either (i), (ii) or (iii) above.

(c) An Intermediary should take a holistic approach, and take into account the following factors when assessing the background of the person responsible for making investment decisions on behalf of the CPI and whether that person is competent and suitably qualified:

(i) the person's investment experience and history, directly relevant and related to the relevant products and markets

(ii) the person's work experience in the financial sector, directly relevant and related to the relevant products and markets

(iii) the person's academic and professional qualifications, directly relevant and related to the relevant products and markets.

(d) An Intermediary should not rely totally on written representations, and should holistically review and assess the information and documents provided (including maintaining a proper audit trail of the enquiries made and information obtained, and producing a written account and conclusions) to determine whether the CPI Assessment criteria are satisfied.

(e) In the event where the CPI is effectively controlled by a single individual or a small number of individuals and lacks the necessary substantive investment processes and controls, it is unlikely that it will satisfy the CPI Assessment criteria, even if the individual(s) is/are financially experienced.

Description of Services in Client Agreements
Under the Code of Conduct, Intermediaries are required to enter into a written agreement with each client before services are provided to the client (Client Agreement), unless otherwise exempt. As prescribed under paragraph 6.2(d) of the Code of Conduct, a Client Agreement should contain "a description of the nature of services to be provided to or available to the client". In the Consultation Conclusions, there have been proposals to amend paragraph 6.2(d) to require clear descriptions, and disallow contractual terms that are inconsistent with the Code of Conduct obligations or that mis-describe the actual services, in Client Agreements. The SFC decided not to proceed with amendments to paragraph 6.2(d) and instead provide guidance in the FAQ regarding the application of paragraph 6.2(d).

With regards to the application of paragraph 6.2(d), the SFC stated in the FAQ that:

(a) Intermediaries are only expected to include descriptions of services that are relevant to the regulated activities for which they are licensed or registered to engage in.

(b) Intermediaries are not expected to include descriptions of services that fall outside the scope of regulated activities.

(c) Intermediaries should clearly and accurately describe in Client Agreements the nature of the account, the types of services relating to the relevant regulated activities to be provided, the nature of the relationship; and the types of financial products involved.

(d) Intermediaries who provide different types of regulated services under a Client Agreement through different types of accounts should set out in specific terms the types of those services to be provided through each particular type of account.

Looking Forward
The practical considerations set out in the FAQ provide clarity on what Intermediaries are expected to do to comply with the CPI Assessment criteria and the requirement under paragraph 6.2(d) of the Code of Conduct in relation to Client Agreements. Intermediaries are reminded to review their current assessment procedures in relation to CPIs and their Client Agreements to ensure that the considerations set out in the FAQ have been taken into account.