disclosure and transparency and other regulatory measures to prevent mis- selling of financial...

Disclosure and Transparency and other Regulatory Measures to Prevent Mis-selling of Financial Products

28 October 2013

Stephen PoSenior Director, Intermediaries Supervision, Hong Kong Securities and Futures CommissionChairman, IOSCO Standing Committee on Regulation of Market Intermediaries

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Outline

Regime for information disclosure and transparency

– Key requirements relating to information disclosure

Reducing mis-selling of financial products

– IOSCO’s efforts in enhancing regulation of selling of investment products

Major challenges ahead

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(I) Regime for

Information Disclosure and Transparency

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Information Disclosure

Disclosure of key product information by product issuers

– Key facts

– Investment objectives and strategy

– Key features

– Key risks

– Fees and charges

– Any guarantee/ collateral

– Scenario analysis / performance of the product

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Information Disclosure

Disclosure of key information by product distributors

– Make adequate disclosure of relevant material information in its dealings with its clients

– Not advise or deal in relation to a transaction for which it has an actual or potential conflict of interest unless it has disclosed that material interest or conflict to the client and it has taken all reasonable steps to ensure fair treatment of the client

– Disclose to clients benefits received from the product issuer for distribution of investment products

– Disclose to clients sales related information, e.g. whether it is acting as principal or agent and its affiliation with the product issuer

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Examples of Product Related Disclosure Requirements

i) Marketing Materials

General principles: The marketing materials should:

– not be false, biased, misleading or deceptive

– be clear, fair & present a balanced picture with adequate risk disclosure

– contain information that is timely & consistent with offering documents

Specific content requirements covering the following key areas:

– the use of language and graphics: should not give the impression that investors cannot lose money or profit without risks (e.g. safe, promise)

– the financial performance and comparative information disclosure

– the inclusion of warning statements

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ii) Offering document and Product Key Facts Statements (KFS)

Offering document: list out the product nature, structure, terms and conditions, risk factors, financial information, etc

KFS: a standardized template summarizing key features and risks of products to help investors to understand and compare different products:

Basic features:

– Quick facts

– Product description (e.g. investment objectives, strategy, key risks, etc)

– Additional information (e.g. the frequency of the NAV calculation)

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(cont’d)

Unique features specific to each product class, e.g.:•additi

onal risk disclosure if the fund will invest in financial derivative instruments for investment purposes

General fund

•key terms of the guarantee

•performance analysis under worst, base and best case scenarios of the structured pay-outs

Guaranteed fund / fund with structured

pay-outs

•constituent stocks making up the underlying index

•collateral/counterparties for funds using synthetic replication strategies

Index fund

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Disclosure Sample of a Structured Investment Product

Key risk factors: Not same as investing in

the underlying assets max potential gain is

capped Not principal protected

Key features: special features such as

callable and airbag max potential gain &

conditions for this to be achieved

various payout scenarios

Details of guarantee/collateral

Scenario analysis: best, middle-of-the road

and the worst case scenarios

Mode of settlement: Cash or physical

settlement upon maturity

Cooling off period: How long How to exercise the right How to calculate the refund

Continuing disclosure obligations: issuer ceases to meet any of

the eligibility requirements failure of a material portion of

the collateral

Quick facts:offer period, issue price & date, min investment, maturity date, max loss/gain, product type

Fees and charges

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(II) Reducing Mis-selling

of Financial Products

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Growth Opportunity in the Selling of Capital Market Products Wealth accumulation worldwide

Capgemini and RBC Wealth Management World Wealth Report

– Population of high net worth individuals (“HNWIs”) increased to 12 million in 2012 (11 million in 2011) and overall wealth amounted to US$46 trillion (US$42 trillion in 2012)

– HNWIs mean those individuals with US$1 million or more at their disposal for investment

Wealth management/ financial advisory services in the Capital Market is a growth business

– Pool of wealth is growing and the need for capital preservation is great

– Investors are demanding yield enhancement under low interest rate environment

No. of HNWIs in 2012 Wealth

Asia Pacific 3.68 million US$12.0 trillion

North America 3.73 million US$12.7 trillion

Europe 3.41 million US$10.9 trillion

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Examples of Cases Involving Investor Losses European countries, e.g.

– Germany – “Zertifikate” sold by banks to private investors

– Spain – Lehman products

– UK – Interest rate derivatives, Isa funds & investment bonds

Hong Kong and Singapore

– Lehman Minibonds

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IOSCO’s Efforts in Enhancing Regulation of Selling of Investment Products “Point of Sale Disclosure” Report published in Feb 2011 covering what

key information that customers ought to receive at the point of sale in order to support sound investment decision making

6 principles on Key Information:

1. Disclose to investors fundamental benefits, risks, terms and costs of the product and intermediary remuneration and conflicts.

2. Provide such information to investors for free before the point of sale to help them make an informed decision about whether to invest.

3. Deliver or make the information available in a manner that is appropriate for the target investor.

4. Should be in plain language and in a simple, accessible and comparable format to facilitate a meaningful comparison with competing products.

5. Should be clear, accurate and not misleading to the target investor. Disclosures should be updated on a regular basis.

6. When making rules for intermediaries and product producers, regulators should consider who has control over the information to be disclosed.

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IOSCO’s Efforts in Enhancing Regulation of Selling of Investment Products

“Suitability Requirements with respect to the Distribution of Complex Financial Products” Report published in Jan 2013 set out 9 principles relating to the distribution of complex financial products by intermediaries

The 9 principles cover the following areas:

– Classification of customers

1. Intermediaries should be required to adopt and apply appropriate policies and procedures to distinguish between retail and non-retail customers when distributing complex products. The classification of customers should be based on a reasonable assessment of the customer concerned, taking into account the complexity and riskiness of different products. The regulator should consider providing guidance to intermediaries in relation to customer classification.

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– General duties irrespective of customer classification

2. Intermediaries should be required to act honestly, fairly and professionally and take reasonable steps to manage or mitigate conflicts of interest through implementing appropriate procedures in the distribution of complex financial products, and where there exists a potential risk of damage to the customer’s interest, the intermediaries should, where appropriate, be required to clearly disclose the risk.

– Disclosure requirements

3. Customers should receive or have access to material information to evaluate the features, costs and risks of the complex financial product. Any information communicated by intermediaries to their customers regarding a complex financial product should be communicated in a fair, comprehensible and balanced manner.

– Protection of customers for non-advisory services

4. When an intermediary sells a complex financial product on an unsolicited basis (no management, advice or recommendation), the regulatory system should provide for adequate means to protect customers from associated risks.

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– Suitability protections for advisory services (including portfolio management)

5. An intermediary should be required to take reasonable steps to ensure that recommendations, advice or decisions to trade on behalf of a customer are based upon a reasonable assessment that the structure and risk-reward profile of the financial product is consistent with such customer’s experience, knowledge, investment objectives, risk appetite and capacity for loss.

6. An intermediary should have sufficient information in order to have a reasonable basis for any recommendation, advice or exercise of investment discretion made to a customer in connection with the distribution of a complex financial product.

– Compliance function and internal suitability policies and procedures

7. Intermediaries should establish a compliance function and develop appropriate internal policies and procedures that support compliance with suitability requirements, including when developing or selecting new complex financial products for customers.

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– Incentives

8. Intermediaries should be required to develop and apply appropriate incentive policies designed to ensure that only suitable complex financial products are recommended to customers.

– Enforcement

9. Regulators should supervise and examine intermediaries on a regular and ongoing basis to help ensure firm compliance with suitability and other customer protection requirements relating to the distribution of complex financial products. The competent authority should take enforcement actions, as appropriate. Regulators should consider the value of making enforcement actions public in order to protect customers and enhance market integrity.

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IOSCO to review the impact of social media and automated advice on the sale of financial products

– Automated Advice

An interactive tool that either broadly or specifically produces recommendations for asset allocation, specific securities or trading strategies

IOSCO is assessing how intermediaries use automated tools to make or facilitate investment advice or recommendations to customers.

– Social Media

Given that market intermediaries and investors are increasingly using social media websites for conducting business, we are seeking to understand how intermediaries have incorporated these newer modes of communication into their operations.

Examples of social media websites: blogs, micro-blogs, Facebook, YouTube, LinkedIn and Twitter

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Other International Regulatory Initiative

UK FCA published a paper on behavioural economics exploring how people make financial decisions

– Many products are inherently complex

– Many products involve trade-offs between the present and the future

– Decisions may require assessing risk and uncertainty

– Decisions can be emotional

– Some products permit little learning from past mistakes

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(III) Major Challenges Ahead

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Major Challenges Ahead

People

Investors’ knowledge and behaviour

– Investor may not be knowledgeable enough to make a rational investment decision. Rely on the specific and extensive expertise of financial planners

– Issues relating to investor behaviour

E.g. emotional, overconfidence and fear of loss of opportunities

Professional financial planners

– May respond to investor demand without realising that this is driven by investor biases *

– Expected to conduct business with high level of integrity and professionalism

* References have been drawn from UK FCA’s occasional paper no. 1 – Applying behavioural economics at the FCA

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Product

Specific product regulation

– Disclosure of product information in a specific way

– Certain products be sold only through particular channels (e.g. on the exchange) or to certain types of clients (e.g. professional investors) *

Whether monetary incentives like gifts should be allowed for promoting investment products

* References have been drawn from UK FCA’s occasional paper no. 1 – Applying behavioural economics at the FCA

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Practices

Perceived conflicts of interest

– Recommendation of particular investment products to customers should not be determined purely by financial incentives received

– Review of sales culture to focus more on compliance, sales quality and customer satisfaction

Commission based vs fee based structure

– Banning of provision of commission rebates by product providers to investment advisors in the UK and Australia

– Whether this will start a trend to change to fee-based transaction model or asset- based pricing model

Ensuring suitability

– Core of financial planning

– Client profiles now evolving rapidly. Need to be more interactive with clients and obtain more accurate and updated information from clients

Technology changes the way financial planners interact with their customers

– Use new IT medium for promotion of investment products

– Use automated advice tools

disclosure and transparency and other regulatory measures to prevent mis- selling of financial...

Documents

product slide

product issuer slide

financial information

disclosure sample

disclosure obligations

product distributors

product class

product nature