28 September 2009
The Securities and Futures Commission of Hong Kong (“ SFC ”) has, on Friday
25 September 2009, published a Consultation Paper on Proposals to
Enhance Protection for the Investing Public (the “ Consultation Paper ”). This paper sets out the SFC's proposals for a major reform of the regulatory regime for unlisted investment products sold to the retail public following the
Lehman Minibonds incident, and marks an effort to restore trust and confidence in the market for such products. The proposals have implications both for product providers and for distributors of structured products. The
SFC’s approach is to retain but improve on the existing disclosure-based approach and to couple this with enhanced regulation of intermediaries' conduct.
Further consultations are promised before the end of the calendar year for legislative change – including consolidation of the Companies Ordinance offering requirements for structured products into the Securities and Futures
Ordinance – and the appointment of a financial ombudsman.
The Consultation Paper includes a new draft Handbook for Unit Trusts and
Mutual Funds, Investment-Linked Assurance Schemes and Unlisted
Structured Products (the “ Handbook ”). The Handbook has, as Appendices, draft Codes applicable to the relevant products. These are the existing Code on Unit Trusts and Mutual Funds (the “ UT Code ”) and Code on Investment-
Linked Assurance Schemes, to which changes are being proposed, as well as the draft Code on Unlisted Structured Products (the “ SP Code ”), which is a wholly new product code. The focus of the Consultation Paper is on the new draft Structured Products Code and the changes to the two other Codes are more restricted in nature.
Application across all products : for the first time, a single Handbook will apply to all unlisted retail structured investment products including:
> structured notes linked to equity, index, credit and other assets
1 SFC enhances protection for Hong Kong investors | 28 September 2009
“The proposals have implications both for product providers and for distributors of structured products.”

> structured securities (such as equity-linked investments)
> regulated investment agreements including structured deposits, contracts for differences and potentially, OTC derivatives that are offered to retail investors.
Excluded from the scope of the Handbook are certain products that are governed by separate product codes, namely, real estate investment trusts, listed structured products, mandatory provident fund schemes, pooled retirement schemes and immigration-linked investment schemes. Also excluded are retail investment products that have as their underliers currency and interest rate products, as these are generally regarded as banking transactions or treasury instruments of banks.
If the planned reforms are implemented, the same general rules and standards would apply to the offering and advertising of the majority of structured products in the Hong Kong market – this is clearly a desirable objective. As a starting point, the Handbook proposes overarching principles applicable to all investment products and general standards applicable to all product providers as well as guidance on advertisements and other marketing materials.
The SFC proposes requiring offering documents for all products to include user-friendly short form product key facts statements (KFS) that will be in standard form. The SFC recognises that such statements must be concise in order to be user-friendly, and should ideally be no longer than four pages.
The SFC has set out key principles applicable to KFS and sample KFS templates have been included in Appendix B.
Post-sale, the SFC also considers the feasibility of introducing a cooling-off period for investment products, both at the product provider level and at the distributor level. The SFC recognises that a ‘one-size-fits-all’ scheme may not be practicable across all investment products and a certain degree of flexibility should be allowed in the event that there is a secondary market for certain products. In addition, the SFC recognises that such a scheme comes with attendant administrative costs and contemplates that reasonable costs may be passed on to investors.
Standards of disclosure in offering documents and advertisements is a focus of the SP Code. To this end, the SP Code sets out key principles that provide guidance as to the standards of disclosure that the SFC will expect from offering documents. The core principle for offering documents continues to be that the offering document must contain the information necessary for investors to make an informed judgment regarding the investment proposed to them. The overarching principle for advertisements is that advertisements must not be false, biased, misleading or deceptive and must present a balanced picture of the structured product. The existing requirements for advertisements have been codified into proposed Advertising Guidelines.
The SP Code also proposes that issuers (via distributors) have ongoing disclosure of material information . Issuers should now provide certain information on an ongoing basis to investors, including financial updates, any
2 SFC enhances protection for Hong Kong investors | 28 September 2009
“The SFC proposes requiring offering documents for all products to include user-friendly short form product key facts statements that will be in standard form.”

material adverse changes affecting the issuer, guarantor and ‘key product counterparties’ (a new concept in the SP Code) or any material failure of collateral.
Eligibility requirements for issuers and guarantors have been introduced including net assets and ratings requirements and a requirement that such entities must be of good standing and not subject to insolvency proceedings.
In practice, such requirements will not be difficult to comply with.
Where the issuer of a product is a “bankruptcy-remote orphan” special purpose vehicle, a number of additional structural and eligibility requirements are proposed.
The SFC has also proposed that issuers appoint product arrangers (who would be licensed by the SFC or registered with the HKMA) in certain circumstances and who would be answerable to the SFC for certain administrative matters and ongoing regulatory compliance in relation to the particular product. It is proposed that product arrangers would need to be appointed by all SPV issuers. Additionally, the SFC has suggested that this requirement might apply more widely such that a product arranger would need to be appointed whenever a structured product is issued by an entity which is not regulated in Hong Kong.
In relation to collateralised structured products, criteria applicable to collateral for collateralised structured products have been introduced. In general, collateral assets must satisfy certain requirements in order to be eligible, including liquidity and ratings requirements. The collateral must be marked-tomarket daily and must also satisfy certain on-going requirements. The Code also sets out applicable risk disclosures.
The SFC also proposes that the underliers of structured products satisfy certain eligibility requirements . For example, where the underliers are equity securities, indices or funds, the assets must satisfy the eligibility requirements for listed structured products.
Issuers of structured products must provide regular indicative valuations and a liquid market for such products, in order to enable investors to exit their investment.
The proposed revisions to the UT Code aim, among other things, to codify certain existing practices. A key proposal is to introduce “ structured funds ” as a new category of authorised funds (together with a framework for their authorisation). Structured funds refer to schemes that seek to achieve their investment objectives primarily through investing substantially all of the scheme assets in financial derivative instruments (“ FDI ”). Key requirements for structured funds include that the valuation of the FDI must be marked-tomarket and conducted independently, and that uncollateralised exposure to the issuer of any FDI (including the relevant counterparty) cannot exceed
10% of the value of the scheme.
“Eligibility requirements for issuers and guarantors have been introduced...”
3 SFC enhances protection for Hong Kong investors | 28 September 2009

The proposed revisions to the UT Code also aim to provide a broadly level playing field between UCITS III schemes and non-UCITS schemes (many of which are managed by local fund managers) with respect to their investments in FDI. UCITS III schemes benefit from considerable flexibility under EU legislation to invest in FDI. It is proposed to provide non-UCITS schemes with equivalent flexibility through the creation of a new category of authorised funds (covering non-UCITS schemes that invest substantially in FDI ). It is also intended that this will encourage innovation by non-UCITS schemes.
The sales process for retail and non-retail structured products is governed by the SFC Code of Conduct. The SFC does not propose major revisions to the
Code of Conduct, but only to particular areas relevant to the sales process.
The process for investor characterisation is a focus of attention. As part of the “know your client” process, the SFC proposes that intermediaries should seek to determine the level of derivatives knowledge of investors (other than professional investors). Intermediaries would not be permitted to promote derivative products other than to professional investors or investors who are classified as “clients with derivative knowledge”.
The SFC is considering raising the minimum asset portfolio requirement for professional investors and is also proposing that such investors be required to have previous experience with investing in “relevant products and markets”.
Other areas for consultation include whether gifts should be used to promote investment products, and the highly-sensitive area of pre-sale disclosure of intermediaries’ commissions and other benefits . However, the SFC has not taken the opportunity to provide further clarification as to when the product suitability obligations are triggered and as to the meaning of “solicitation”.
For more information please contact any of the following people or your usual Linklaters contact:
Andrew Malcolm
Tel +852 2842 4803 andrew.malcolm@linklaters.com
Chin-Chong Liew
Tel +852 2842 4857 chin-chong.liew@linklaters.com
I-Ping Soong
Tel +852 2901 5181 i-ping.soong@linklaters.com
Carl Fernandes
Tel +852 2842 4186 carl.fernandes@linklaters.com
Umesh Kumar
Tel +852 2842 4894 umesh.kumar@linklaters.com
This is clearly a key milestone in the landscape for retail structured products in Hong Kong and we will be conducting seminars to further discuss the main issues and deal with key questions.
This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors.
© Linklaters LLP. All Rights reserved 2009
Linklaters LLP ( www.linklaters.com
) is a limited liability partnership registered in England and Wales with registered number
OC326345. It is a law firm regulated by the Solicitors Regulation Authority (www.sra.org.uk). The term partner in relation to
Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of Linklaters LLP members together with a list of those non-members who are designated as partners and their professional qualifications may be inspected at our registered office, One Silk Street, London EC2Y 8HQ and such persons are either solicitors, registered foreign lawyers or European lawyers.
We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by emailing us at marketing.database@linklaters.com
.
4 SFC enhances protection for Hong Kong investors | 28 September 2009