Council's Views on the Proposed Guidelines on Online Distribution and Advisory Platforms
4 August 2017
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1. The Consumer Council (the Council) is pleased to submit its views to the Securities and Futures Commission (SFC) in relation to a consultation paper on the proposal to introduce the Guidelines on Online Distribution and Advisory Platforms (the Guidelines).
2. In light of the availability of many online financial services platforms, which provide financial information and data and investment advice, offer investment products and securities trading in Hong Kong, and the increasing demand on these online services, the Council welcomes the SFC’s initiative to issue the Guidelines safeguarding the interests of investors and consumers. The Guidelines will remind platform operators that there are requirements on the design and the operation of the online platforms and also clarify the application of the Suitability Requirement in the online environment.
3. The Council believes ensuring retail investors not been misrepresented or not been sold investment products misaligned with investor's risk profile is of utmost importance from the perspective of investor protection, regardless of whether the information provision, investment services or trading process is taken place on an offline or an online environment.
4. In this submission, the Council has set out its views and comments along the following four main areas: (1) the core principles for governance and controls of online platforms; (2) the application and discharge of the Suitability Requirement under which context in the online environment; (3) the unsolicited advice and offer of complex products on online platforms; and (4) investor education as well as the applicable scope of the Guidelines.
Applicable Scope of the Guidelines
5. The Council understands that the SFC has different types of licenses to govern the different regulated activities which include the conduct of intermediaries, the disclosure requirements on investment products and the operation of market infrastructure and trading. Taking into consideration the fast proliferation of online platforms offering easy and convenient access to any investors and the growing trend of social media sentiments that Key Opinion Leaders (KOLs) share and discuss trade ideas with followers which may form the decision-making of the investors, the Council urges the SFC to put up more resources in its surveillance and enforcement against non-licensed or non-registered persons to better protect the interests of Hong Kong investors.
6. It is noted in the consultation paper that the Guidelines will be applicable to any activities targeting Hong Kong investors conducted by a SFC-licensed or registered person via all online channels, including conducting transactions in websites or posting information about investment products on platforms and other channels such as social media. Online platforms can operate globally, not bounded by their physical or server locations or jurisdiction boundaries, and be easily accessible to any investors. Unless the online platforms taking reasonable steps make their financial advice and transaction services inaccessible by Hong Kong investors, they will have legal liability for not complying with the Hong Kong regulations if they provide advice and facilitate transactions for Hong Kong investors. The Council is of the view that online platforms being operated by non-SFC-licensed or registered entities which make their financial advice and transaction services easily available to Hong Kong investors, they should also be informed and be included in the supervisory focus of the SFC.
7. In addressing the potential risk of regulatory arbitrage, the Council would expect the SFC to fulfill its regulatory mandate of promoting investor protection by engaging in greater international co-operation among relevant authorities in matters pertaining to cross-border availability of services that offer trading functionalities or investment advice on securities accessible to Hong Kong investors.
8. The Council also concerns people using social media to conduct solicitation activities or offer investment advice anonymously to Hong Kong retail investors. Given the anonymous nature of some of the social media sites and the possible use of unidentified social media accounts, it may be difficult to know and identify if the person posting information or facilitating transaction is a SFC-licensed or registered person or not, and thus the compliance relevancy as well as liability would be a regulatory challenge to the SFC. The Council opins that there should be a requirement on the person to make a declaration of interest, if have received any commercial interests for making recommendations or advice, that use social media platforms for investment advisory purpose. Consumers/investors should be encouraged to report any undesirable solicitation activities or illegal investment advice in social media.
Core Principles for Operation of Online Platforms
9. In addition to the existing regulatory framework and conduct requirements, the Council notes that the SFC introduces six core compliance principles under the Guidelines, on how the online platforms would be regulated. The six core principles are:
(i) Proper design of online platform;
(ii) Provision of clear and adequate disclosure of relevant material information;
(iii) Risk management regarding reliability and security;
(iv) Governance, capabilities and resources for proper operation and control;
(v) Ongoing review, supervision and monitoring; and
(vi) Maintenance of proper records.
10. The Council supports these principles and opins that online platforms make their services widely available and easily accessible to investors, they should act responsibly to safeguard their customer interests.
11. As regards the proposed core principle about the provision of information to clients, the Council proposes an additional disclosure requirement that any SFC-licensed or registered persons should post their licensing status on their online platforms. Users of these platforms would be aware that the platform operators are operated by SFC-licensed or registered persons. Such information will facilitate the choice of investors to engage with online platforms that are certainly regulated under Hong Kong provisions against those anonymous or online platforms not licensed or not registered under the SFC.
12. More transparency and information disclosure can facilitate investors to understand and assess risks of an investment they are exposed to. Online platforms when making solicitations or recommendations should be required to make clear and adequate disclosure of relevant information. The Council considers information transparency related to "when" and "how" the information presented to the investors is important.
13. There should be requirements on (i) when the information should be made known to the investors, particularly before they make the transaction; (ii) the way the information is filtered, shaped or personalised, especially how and when this information forms the basis of recommendations or advice or influences the investors' decision; and (iii) the nature of the investment product that investors view or transact online. Non-disclosure of the limitation on services and products being provided by online platforms should be treated as violating the core principles.
14. Regarding the minimum information to be provided, the Council considers that in addition to the provision of product nature and key terms and features of the investment products at the upfront, platform operators should be capable to utilise the Internet to promptly provide clients with information concerning their investments on an ongoing basis to ensure that investors are well informed of any changes in the market conditions such as the occurrence of a major event that may lead to increase in the risk level of the investment products concerned.
15. Apart from implementation of proper control, policies and procedures of the online platforms, the Council suggests that platform operators should be required to set up easily accessible channels and provide contact information to address queries and complaints from their clients. Service pledges on timely disclosure of trade confirmation, provision of investment statements and lead time on replying investors' enquiry and complaint, should also be established and clearly stated in the platforms.
16. Information about investor rights and restrictions (such as how the online platform deals with cancellation of services and orders), any risks relating to the use of that facility, client money and investments arrangements and safeguards, personal data (privacy) protection, and IT security measures (including explanation of what would happen in the event of the failure of the platform), should also be available on the platform to help investors understand the operation, the risk of investing and their rights and responsibilities.
17. The Council is also of the view that platform operators using robo-adviser are required to disclose accurate and comprehensible information on the nature, limitations, risk and how key components of their services are generated. The Council supports where there are changes to the existing algorithm that may materially affect clients' portfolios should be clearly and promptly informed of such changes to relevant clients.
18. Though it is required under the core principles that any online platforms that any algorithms installed should not be programmed to direct clients towards particular investment products for which the platform or its affiliates receive higher commission or other forms of compensation, the Council is of the view that robo-advisers should disclose clearly and explicitly at the outset to investors in their online platforms if there is any potential conflicts of interest.
Application and Discharge of the Suitability Requirement
19. The Council supports the SFC's guidance on how the Suitability Requirement would operate in the context of an online platform particularly under the provision of automatic or robo-advice on the platform. It is understood that the Suitability Requirement is an investor protection measure in the sale of investment products. The Council welcomes that the SFC views a solicitation or recommendation, whether offered by a person or a robot or interactive algorithm, itself triggers the Suitability Requirement, to provide greater investor protection.
20. Without the Suitability Requirement on "solicitations" and "recommendations" by online platforms, unsatisfactory results may occur through problematic design (an algorithm driving the advice may be designed to consider limited investment options from among a predetermined set of alternatives) or mistakes in the programming itself which could lead to systematic mis-selling of some investment products to clients or to making investment decisions by the algorithm that may not be in the client's best interest. Robo-advice may be inappropriate also if the algorithm fails to account for changes to reflect the client's personal circumstances.
21. An automatic profiling process with continuous updating the trading practices and selection of the information provided by the investor enables the online platform to better understand its clients' suitability of certain advice or recommendations than a process relying only on a standard set of questions. Since the online platform should easily align its recommendation with the data profile and the risk of the investor, the Council considers that there is no reason why they should not be required to comply with the Suitability Requirement.
22. As to "execution-only" platforms (the Suitability Requirement will not be triggered as proposed), where less sophisticated investors may demand tools and services that offer more guidance and direction. The execution-only platform may have so called "statistical" tools or "analytical" services biased to some guidance or particular direction, which could blur the line between "execution-only" and "advice and recommendations". In such a scenario, the Council is concerned whether the Suitability Requirement should be applied. The SFC should reconsider whether "execution-only" platforms should be exempted under such circumstance.
23. As the advice rendered and the automation involved are very complex, the Council considers that traditional record keeping and audits monitoring the Suitability Requirement may not be adequate. Different surveillance approach leveraging technologies may be needed to evaluate the compliance of the online platforms on the Suitability Requirement.
Sale of Complex Product on Online Platform on an Unsolicited Basis
24. Owing to the high complexity of certain investment products which are not likely to be understood by an average retail investor, the Guidelines also suggest the extension of the Suitability Requirement to the sale of complex products on online platforms and that platform operators are required to ensure any transaction in a complex product is suitable for the investor in all the circumstances. The Council supports the proposal that the same requirement should be applied to offline and online sales of complex products as the level of investment experience and knowledge required from an average retail investor to fully understand the complex structure of a product shall not be different from the online or offline environment.
25. With regard to online investment tools or search/comparison websites, consumers/investors should also be aware of feedbacks by the algorithm or the website's reliance on certain assumptions and recommendations offered by algorithms that would be based on the personal profile portrayed by the investor which may not be exact description of the person, for example, there is always a tendency to understate the age and provide false financial status for required information input by online platforms.
26. The Council appreciates that the SFC will work with the Investor Education Centre on additional educational materials for investors who use online platforms. As suggested above, the Council is of the view that consumers/investors should be educated about (i) the risks and limitations of online distribution and advisory platforms; (ii) the application and operation of the Suitability Requirement in the online environment; and (iii) interdependent between information provided and behavioural practices and the design of the algorithm installed in the online platforms.