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View from Asia: Ongoing legal and compliance risk in Asia

Across the global markets, there are potential showstopper development risks for financial services businesses that can be readily identified, including obstacles to international cooperation in developing a coordinated architecture, eg for recovery and resolution, OTC derivatives trading, clearing and reporting and cybersecurity. In addition to such macro-level issues, day-to-day compliance and operational risks must not be ignored. The evolution of regulators’ treatment of “standard” issues such as suitability obligations and client classification must be carefully monitored by intermediaries. Simply relying on established policies or previous professional advice as to how such obligations need to be satisfied could be a risky strategy. Unquestioning reliance would, over time, potentially create compliance gaps between the evolved policy and the intermediary’s – albeit considered – stance.

Continuing awareness of changes, not just to regulatory provisions but also to guidance, frequently asked questions (FAQs) and pronouncements of regulators in a jurisdiction, remains one of the highest legal and regulatory risks for an intermediary in designing and implementing its compliance framework. There is normally no valid “ignorance” defence and “market practice”-based arguments are often extremely challenging to make successfully.

A case in point – suitability requirements

An example of evolving operational risk is the umbrella issue of the “suitability” of a recommendation or solicitation of a product to a client. Suitability is a core element of the underlying need to know our client that forms part of most developed regulatory regimes.

Hong Kong’s regulatory regime is a case in point: when an intermediary makes a “recommendation” or “solicitation” to a client, it should ensure the “suitability” of the “recommendation” or “solicitation” for that client is “reasonable in all the circumstances”. Singapore, as a comparator, has a broadly similar, but not identical requirement and treatment.

The Hong Kong securities regulator, the Securities and Futures Commission (SFC), has recently issued two circulars exploring FAQs for regulated intermediaries, concerning when such suitability obligations would be triggered and how intermediaries can comply with their suitability obligations from a compliance perspective.

The FAQs are designed to act as a reminder to intermediaries of their suitability obligation under the Code of Conduct for Persons Licensed by or Registered with the SFC (Code of Conduct) and provide guidance on what they mean in practice. Importantly, amendments to the Code of Conduct for intermediaries, published by the SFC,1  require intermediaries to incorporate a suitability clause into their client agreements by 9 June 2017. This adds a contractual suitability obligation to the existing regulatory obligation. Once the new client agreement requirements have taken effect, the potential for contractual liability will inevitably mean that adherence to the suitability obligation will assume even greater significance.

Failure to heed the guidance contained in the FAQs would mean that previously embedded policies and procedures would continue to govern suitability management for an intermediary, which would likely create compliance and disciplinary issues down the line, and may increase the risk of contractual disputes as a result of the new client agreement requirements.

Professional investors – knowledge can be power

Ignorance of evolving policy can also reduce a financial service provider’s competitive edge.

For example, the SFC has recently embarked on a consultation exercise with the Hong Kong market (following an earlier soft consultation with industry participants) on proposed changes to the gateway issue of who can qualify to be treated as a “professional investor” (essentially institutions and sophisticated investors) for various purposes under the legislation and the Code of Conduct, without (in the case of the Code of Conduct) affecting how they are handled once they have so qualified.

Essentially, the proposals amount to a formal expansion of the class of persons who can be treated as professional investors under the Hong Kong regime. The proposals are likely to be welcomed by asset managers and private banks, since there would be more flexibility for treating individuals as professional investors.

Interestingly, the proposals principally act as a codification of various previous individual modifications – essentially waivers – granted by the SFC to certain intermediaries over time, on a case-by-case basis. As a result of the proposed changes, all market participants would be able to take advantage of the substance of those modifications without first having had to make an application to the SFC (when a particular client did not as a technical matter fit within the definition as it stands under the legislation).

The current lack of transparency in respect of such modifications could mean that if a market participant simply relied upon the statutory definition of a “professional investor” it may as a result potentially have been prevented from dealing with a client in certain circumstances, notwithstanding that a relaxation may have been applicable, and indeed readily available in practice, from the SFC if the participant had been aware of that modification.

As a demonstration of the interlocking nature of regulatory provisions and the inherent risk of treating issues on an isolated basis rather than holistically, it should be borne in mind that the effect of a client or potential client being treated as a “professional investor”, or not, has a potential knock-on effect for how that client should be treated in the context of the suitability obligation discussed above: certain types of professional investor clients are not subject to the suitability obligation.

Finally, the importance of international regulatory convergence cannot be under estimated given the parallel use of similar (sometimes identical) concepts and terms in different jurisdictions where an intermediary may be operating. Local statutory interpretation, interpretation of guidance and rules (or equivalent) from relevant regulators, and regulators’ pronouncements need to be keenly monitored. In addition, a holistic view of how they fit into the regional and global environment needs to be equally carefully managed to create appropriate synergies within the compliance function of a cross-border intermediary.

Footnotes Web/gateway/EN/circular/openFile?refNo=16EC15

Further information

This case summary is part of the Allen & Overy Legal & Regulatory Risk Note, a quarterly publication.  For more information please contact Karen Birch –, or tel +44 20 3088 3710.

Legal and Regulatory Risk Note