Time is running out for responses to the Securities and Futures Commission's current consultation paper titled: 'Proposals to enhance protection for the investing public', which is due to close on 31 December.

The SFC is proposing to require disclosure to clients at the pre-sale stage of all commissions, fees and other benefits receivable from product issuers for the sale of the products - including unlisted structured products. It has said the new rules will not apply to listed structured products as they are already: "... subject to a well-established regulatory framework under the Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong and the oversight of The Stock Exchange of Hong Kong.

In terms of the proposed new rules which will affect unlisted structured product sales in Hong Kong, the key proposals in the Consultation, are:
1. Enhancing disclosure:

(a) a requirement for a Product Key Facts Sheet (KFS);
(b) standards for disclosure in offering documents;
(c) standards for disclosure in advertisements; and
(d) requirements for ongoing disclosure of material information;

2. Increasing product transparency:

(a) eligibility requirements for Issuers and Guarantors (including special purpose vehicle Issuers);
(b) a requirement for the appointment of, and obligations and responsibilities imposed on, Product Arrangers, in certain cases;
(c) criteria for eligibility of collateral;
(d) criteria for eligibility of reference assets;
(e) a requirement for provision of regular indicative valuations of the structured product;
(f) a requirement for regular liquidity provision.

To have your say on the consultation paper, visit https://www.sfc.hk/sfc/html/EN/inutilbar/contact/consultationMail.html before 31 December 2009.

Innovative Investor speaks with Paul Kennedy, chief operating officer at the Securities and Futures Commission about the consultation paper and what it means for the sale of structured products in Hong Kong.

II - Most of the areas of contention surrounding this consultation have been around commission disclosure and the cooling off period, so how do you respond to allegations you are using a sledgehammer to crack a nut?

Paul Kennedy - Commission disclosure and cooling off may be new to Hong Kong but they are not new everywhere else, which is a point many people seem to overlook when they complain about the proposals. If the Consultation document is read properly, people would realise how limited these proposals are and there is perhaps an overreaction to the fact that a limited cooling off period has been proposed. The issue of moral hazard is recognised as being very important when considering the cooling off period and we don't want to create a situation where there is a 'free lunch', because that would create unhealthy behaviour.

II - The UK implemented key facts illustrations a few years ago and there was great confusion at the time as to what to include and what not to include. Without strict guidelines are you not worried that the Key Facts Statements will create a lot more work and will investors be more likely to read it?

Paul Kennedy - I am sure some people producing Key Facts Statements will not see it like that but this is not new information. This is just information that should be in the documentation anyway. One of the learning points we have seen as we look back over the last 14 months is that the documentation wasn't as effective at communicating with investors as it could be. That is not because the document was deficient necessarily, but because it was difficult to read. What we are trying to do is pull out some of the most important facts and make them easier to read. In terms of getting authorisation it is covered by the same regulatory requirements as it is an integral part of the overall product documentation. It is very similar to something that has been done in Europe as well.

One concern of structured product issuers is that under the proposal all the existing products out there need to have Key Facts sheets retrospectively. However, there is a period of time to allow this has to happen. We are looking at phasing this in within a 'reasonable' period. And we don't think the cost of adding it in will outweigh the clear benefit of having these summaries.

II - Have you set restrictions over how big the document can get?

Paul Kennedy - We haven't set a maximum size on it because we didn't want to create a situation where people are cramming stuff in, because that would defeat the purpose . In practice when we review the documentation that comes in, we will keep an eye on the length. We think a four-page document is about the right length, but some products will clearly need a bit more than that. The intent is not to be over-prescriptive but it is a difficult balance to achieve because product issuers will want to include all the detail to protect themselves. But equally, this document has to communicate effectively with the investor.

II - Some jurisdictions have already imposed quite stringent changes regarding the sale of structured products, so to what degree have you been influenced by what has gone on before in other parts of the world? For example, Australia and the UK have moved way ahead of most markets in terms of commission disclosure, so by inviting them to Hong Kong are you preparing the market for further changes down the line?

Paul Kennedy - The consultation paper drew references from disclosure of benefits requirements in the UK, the US, Australia and Singapore. All these jurisdictions currently have rules requiring pre-sale disclosure in varying degrees whereby regulated firms are required to disclose to investors the monetary and non-monetary benefits they receive in relation to the provision of services to investors.

When it comes to commission disclosure, the level of disclosure required by ASIC and the FSA is really very detailed. And they are now starting to move beyond this and getting to a point where they are saying no commission can be charged. However, we are definitely not saying that it is inappropriate to earn commission.

II: Is Hong Kong not just following behind these other markets and will eventually decide that it is inappropriate to earn commission too?

Paul Kennedy: Hong Kong is well behind international standard in disclosure of commission. And the lack of transparency around the sales process in terms of what the intermediary earns as commission cannot in my view be justified. . I think any concerns about the potential for increased competition are completely outweighed by the need for transparency and giving the investor all the information that it is appropriate to give them. If you look at the consultation proposals, they are very modest. We are saying we think commission should be disclosed, but there are different ways of doing this. and asking the industry what do you think is the best way to approach this? We are trying to find the point at which the industry can disclose commissions and give the information to the investor in a way that is the least onerous.

II - The Hong Kong Government is currently running 2 consultations - one on investor education and one one dispute resolution. Will the consultation on dispute resolution result in a financial services ombudsman?

Paul Kennedy: There is currently no prescribed mechanism for dispute resolution outside of going back to the original institution or through the courts. We as a regulator cannot get involved in commercial disputes. The upcoming government consultation will address the issue of creating a dispute resolution body.

We've been working on a plan for a new body aimed at improving financial literacy in HK - across the whole financial sector, not just what we have now. At the moment, what we have is a fairly narrow investor education programme for securities products because under our ordinance we are constrained to securities and futures. There is some legislation required to implement the proposed new investor education body, which will be similar to what has been developed in the UK and Australia. The Government will launch a consultation on this in January next year.