SFC’s review of online brokerage, distribution and advisory services

 
On 31 August 2022, the Securities and Futures Commission (the “SFC“) published a circular summarising their key observations from a review of the business models of 50 licensed corporations (“LCs”) which provided online brokerage, distribution and advisory services to their clients.The SFC has invited the public to review and provide comments on the proposed amendments set out in its consultation paper dated 10 June 2022, which aim at:

The review focused on whether the LCs’ online services platforms (i) were properly designed; (ii) operated in compliance with all applicable rules and regulations; and (iii) addressed the risks associated with onboarding clients and distributing or advising on investment products via their platforms.

The fact-finding survey, desktop analysis and inspections conducted by the SFC identified several key observations:

1. 96% of new accounts opened by LCs were through non-face-to-face (“Non-FTF”) client onboarding procedures, with additional incentives provided to clients;

2. there was an increasing number of LCs distributing investment products to clients or executing orders through their online platforms, which products include equities, exchange-traded funds, futures and options contracts, bonds, collective investment schemes and virtual asset-related products amongst other assets;

3. some LCs have added special features in their online platforms, including: (i) technical analysis of stocks for customer’s self-performed market research; (ii) live chat function with AI chatbots; (iii) game-like features; and (iv) social media functions; and

4. a general rise of usage of social media platforms by LCs for marketing and communication purposes.

While investment services delivered through LCs’ online platforms have brought innovation and convenience to investors, the SFC highlighted some key deficiencies in respect of compliance issues:

1.    Proper client identity verification

Some LCs failed to conduct proper client identity verification procedures when onboarding clients online. For example, some LCs failed to recognise clients’ designated bank accounts in Hong Kong or to procure appropriate independent assessment for facial recognition of onboarded clients.

The SFC reminded LCs to conduct proper client identity verification procedures and comply with (i) the relevant regulatory requirements; and (ii)  acceptable account opening approaches for both face-to-face and Non-FTF clients.

2.    Suitability obligations of LCs

When entering into agreements with clients, certain LCs failed to include all potential suitability obligations or requested clients to make blanket acknowledgements for non-solicitation clauses.

LCs are encouraged to follow the Guidelines on Online Distribution and Advisory Platforms published in July 2019 and related FAQs.

3.    Product due diligence

Due diligence is essential for assessing the key features and risks of the products. LCs should comply with the requirements imposed by domestic regulatory authorities, through observing the relevant selling restrictions or any additional regulatory requirements when distributing certain investment products.

4.    Measures for maintaining client risk profile

Some LCs did not put in place adequate measures to identify and assess inconsistent client information or to detect abnormal frequent updates of client’s risk profile questionnaire during the know-your-client process. LCs should establish effective procedures to ensure their clients’ risk tolerance classifications are accurate.

5.    Monitoring mechanisms for accuracy and cybersecurity

It is foreseeable that clients using online platforms may build up a level of loyalty and reliance in using these platforms. As such, any information security issues or system interruptions or outages may affect the operation of LCs and cause lossess and damages to clients.

LCs are reminded to comply with the relevant requirements regarding cybersecurity, including (i) Guidelines for Reducing and Mitigating Hacking Risks Associated with Internet Trading; (ii) Circular to licensed corporations: Review of internet trading cybersecurity; and (iii) Report on the 2019-20 thematic cybersecurity review of internet brokers.

Conclusion

LCs should remain mindful of the applicable regulatory standards and ensure compliance when providing investment trading and advisory services online.

 

It may be prudent to seek advice on any of the potential issues identified above, including:

• conducting (i) periodic internal  reviews or assessments for compliance regarding day-to-day operations and (ii) due diligence for the launch of any new product or service;
• preparing standardised documentation relevant to the operations of LCs;
• structuring and re-designing of online platforms for compliance with regulatory standards;
• liaising with the SFC and other regulators for matters regarding licensing and supervision; and
• advice on collaborations between LCs and other financial institutions for launching products or services.