Banks handed tighter regs on fund due diligence

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SFC’s recently introduced “complex product” regulations have extended retail investor due diligence requirements to professional investors.

The new rules, which came into force on 1 July, “have inflicted retail standards of due diligence on professional investors,” Jeff Floro, sales director for Asia at Fundinfo, told FSA.

“Private banks now need to determine the risks of non-Hong Kong registered funds and products before they can be sold to their [high-net-worth] clients. Mandatory restrictions on sales to retail customers have, of course, been in place for many years, but now unauthorised funds have to be separately assessd for their level of risk.”

The regulations of complex products followed a year-long consultation period and are designed to protect unwary individual investors from their own recklessness, as well as unscrupulous or careless providers.

The SFC’s list of non-complex products are the most vanilla types of instruments and funds, including: Hong Kong-listed shares, straight-forward bonds, and non-derivative SFC-authorised funds, ETFs and Reits.

Now we have to undertake and be able to demonstrate for the regulators due diligence even for unsolicited, execution-only trades

Products defined as complex cover those with futures and derivatives features, deposits with returns linked to equities or other securities, bonds with special aspects such as deferred interest payments and other structured instruments (see flow chart for unauthorised funds below).

“However, the riskiness and appropriateness of complex products can be open to interpretation. There is no standardisation or template that private bankers can use to make their assessments,” said Floro.

Determining the suitability of a particular investment for a client is the “core of the fund and product selection process”, according to a leading Hong-Kong based private banker.

“But now we have to undertake and be able to demonstrate [for the regulators] due diligence even for unsolicited, execution-only trades,” she said.

“This is the most significant effect of the new SFC rules and is our greatest burden.”

It is possible to have factsheets prepared as part of “product due diligence” for authorised funds and straightforward instruments, but it is much harder to have the necessary paperwork already in place for a hedge fund or private equity fund.

“If a high-net-worth client calls to put in an order to buy a hedge fund, then it is likely that we will have to decline the trade because we simply won’t have the necessary information. We could then do the due diligence, but that will take time – especially to meet the SFC’s demanding threshold – and meanwhile the client will have gone elsewhere to make the purchase,” she said.

Assuming that other private banks in Hong Kong would exercise the same integrity, then the client would be forced to make the transaction in a different jurisdiction – unless they struck lucky, and found a Hong Kong competitor that had already completed the due diligence on their opaque hedge fund pick.

A way to alleviate the inefficiencies and delays of data gathering is collaboration.

One such example is the “Openfunds Association” which Fundinfo set up with Credit Suisse, Julius Baer and UBS private banks in 2015, in order to improve the transmission of static fund data.

“It was an effective channel for communicating fund information, making the process accessible and relieving the private banks of time-consuming and expensive manual work during the implementation of MiFID II in Europe,” said Fundinfo’s Floro.

“It should also make operations easier for the Hong Kong fund and private bank industry in this new regime and could be a robust facility if other jurisdictions in the region introduce similar regulations.”

 


Source: Securities and Futures Commission

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