Consumer Council's Views on Proposals to Enhance Asset Management Regulation and Point-of-sale Transparency

22 February 2017
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1.    The Consumer Council (the Council) is pleased to provide its views to the Securities and Futures Commission (SFC) in response to the consultation paper on proposals to enhance asset management regulation and point-of-sale transparency.  The consultation paper comprises of two parts with proposed enhancements made to:

       Part I: The Fund Manager Code of Conduct; and
       Part II: The Code of Conduct for Persons Licensed by or Registered with the SFC (Intermediaries' Code of Conduct).  

2.    As for more relevant to consumers, the Council' s response will focus on the proposals which are directly related to making disclosure and reporting to fund investors, as well as addressing conflicts of interest arising from receipt of benefits by intermediaries from other parties in the sales of investment products to clients.

Fund Manager Code of Conduct

Reporting risk exposures to fund investors

3.    The Council welcomes the proposals of requiring a fund manager which engages in securities lending, repurchase agreements and similar over-the-counter transactions on behalf of the fund it manages to make disclosure in the fund' s offering document, and to inform the fund investors at least on an annual basis and upon request, information relating to such activities and the risk management policies (including haircut policy, selection criteria of securities lending counterparties, collateral policy and the relevant provisions in the securities lending arrangements) adopted, so as to enable the fund investors to have better understanding of the relevant risks and exposures to the fund.

4.    To enhance transparency in non-SFC-authorised funds, the Council supports the SFC' s view that the fund manager should disclose details of non-cash collateral re-use arrangements and related risks to investors. Such disclosure should be adequately made and timely (at least on an annual basis).

Aggregation of house orders with client orders

5.    This can be a problem when a client order aggregates with another client order or a house order which may result in conflict of interest as it can benefit a certain client or the intermediary itself at the expense of other clients.  In view that order aggregation of client orders with house orders is permitted under the current requirement if prior written consent of the client is obtained, the Council considers it important to have a requirement that stipulates a fund manager must act in the best interest of the client and when there is a conflict between the client' s interests and the house' s interest, client' s interests must be given priority.  The Council supports the proposed additional requirement that "aggregation of house orders with
client orders should only be made if it is in the best interests of clients".  

6.    Notwithstanding that a fund manager should have put in place a proper internal control system to address conflicts and ensure fair placement, execution and allocation of orders for the protection of investor interests, the Council is of the view that regulatory surveillance plays a crucial part since regulator can access to and check on relevant information monitoring the compliance of the rules and regulations by intermediaries relating to conflicts of interest and taking immediate actions to address the misconduct.

Others

7.    As a whole, the Council generally supports the proposals of requiring disclosure on the custody arrangements in respect of safekeeping of fund assets and custodian' s independence, and the leverage information in funds, for enhancing transparency to fund investors.

Intermediaries' Code of Conduct

Restriction on the use of the term "independence"

8.    As noted in the consultation paper that a complete ban on receipt of commissions by intermediaries in relation to distribution of an investment product to client may not be appropriate for Hong Kong and hence the current practice of requiring an intermediary to make related disclosure will be enhanced.

9.    The Council supports the proposal of restricting representation by an intermediary as being "independent" or using any other term(s) with similar inference (e.g. "impartial", "neutral", "objective", "unbiased", etc.) if monetary or non-monetary benefits from other parties including product issuers are received, or if it has any link or other legal or economic relationships with product issuers.  Such proposal can protect consumers against the adverse effect of the potential conflicts of interest and product bias as receipt of monetary and/or non-monetary benefits of intermediaries by any party in the sales of an investment product to consumers could undermine independence.

10.    Nevertheless, the Council considers that adopting the concept of "caveat emptor" (let the buyer beware) as the strategy to alleviate intermediary's conflict of interest, the disclosure should be sufficiently complete and timely so that it is meaningful. The information provided should be comprehensible to consumer so that the consumer is aware of the independency of an intermediary on the provision of recommendation or solicitation for investment advice on investment products.

11.    The Council therefore suggests that the "independence" or "non-independence" disclosure should be made available and known to consumers from the beginning of the investment recommendation or solicitation process.  Rather than disclosure just "prior to or at the point of transaction" as proposed in the consultation paper, the Council is of the view that such information should be clearly disclosed at the earliest opportunity as it may affect consumer's choice among different investment intermediaries and products.

12.    In the opinion of the Council, making disclosure at late stage of the transaction would limit the options available to consumers to exercise changes in their investment decisions.  In order for disclosure to be effective and meaningful for the consumer it needs to be complete and timely as noted above.

Disclosure statement on intermediaries' independent status

13.    As regards the proposed disclosure statement in relation to intermediaries' independence set out in schedule 9 of the Code of Conduct, the Council suggests that it should be made mandatory, not on a voluntary basis, for intermediaries to provide a description of the links or other legal or economic relationships with product issuers which may impair the intermediaries' independence in the sale of investment products to the clients.
    
14.    Notwithstanding the current requirement that "where an intermediary only recommends investment products which are issued by its related companies, it should disclose this limited availability of investment products to each client", the Council suggests that such disclosure should also be made in the form of a written statement and be notified to the clients when they received recommendations to limited products with interests related to the fund manager.  

Enhanced disclosure on receipt of benefits

15.    The Council supports the proposal of enhancing the disclosure requirement for any not quantifiable monetary benefits such as trailer fees from a generic form to a more specific disclosure in terms of the range and the maximum amount of monetary receivable on an annual basis.  The Council is of the view that such enhancement will help consumers in making a more informed investment decision.

16.    As noted in the consultation paper that such increased transparency aims not only to encourage consumers to seek quality advice or service from intermediaries but also facilitate competition and drive fees down in the long run.  Nevertheless, similar to the "independence" disclosure, the proposed enhanced disclosure on receipt of benefits is only required to be "prior to or at the point of entering into a transaction" and it is "to be made on a transaction basis".  The Council suggests that a more transparent and competitive approach, for example, to disclose the details of benefits or receivable for the products, should be considered so that consumers can compare fees and charges more easily and make an informed investment decision.

Conclusion

17.    The Council believes that disclosure alone may not be enough to effectively address a conflict of interest, and other approaches such as stringent management control and regulatory oversight are also necessary and required.
    
18.    The effectiveness of disclosure as a tool for addressing conflicts of interest also depends upon the level of sophistication of the client and the extent to which they are able to understand and act upon the information given to them.  For example, different fund houses, distributors or fund types may have different fee calculation mechanisms which are complicated and not easily understood by the investing public.  The Council appreciates that more educational materials will be prepared by the SFC and the Investor Education Centre to enhance investors’ understanding and interpretation of these new disclosures and figures.