The thematic review will assess the spreads intermediaries charge for non-exchange traded investment products such as bonds and structured products.
The HKMA (Hong Kong Monetary Authority) and SFC (Securities and Futures Commission) will commence a thematic review in the second half of this year to assess the spreads charged by intermediaries on OTC products, and other practices they use to manage conflicts of interest.
“Conflicts of interest may arise when intermediaries manage trades for clients,” the HKMA and SFC said in a joint circular.
Thematic review
The thematic review aims to ascertain whether charges may be in excess of the spreads or fees disclosed in the intermediaries’ standard documents to clients, or as agreed with or understood by the clients, and whether spreads may be increased after a trade is executed and the price improvement is retained without agreement with or disclosure to clients.
The review will cover the selected intermediaries’ policies, procedures, systems and controls as well as management oversight of the distribution to clients of non-exchange traded investment products such as bonds and structured products.
It will also cover intermediaries’ understanding of and compliance with requirements governing the disclosure of trading capacity and monetary benefits as required under the Code of Conduct.
Regulatory action
The Code of Conduct provides that intermediaries should act honestly, fairly, and with due skill, care and diligence in the best interests of their clients; make adequate disclosure of relevant material information in their dealings with their clients; and avoid conflicts of interest, and when they cannot be avoided, ensure that their clients are treated fairly.
To comply with these requirements, intermediaries are expected to:
- put in place appropriate policies, systems, controls and management supervision over order handling and spread charges
- properly disclose price, fees, monetary benefits received and trading capacity to clients
- maintain adequate records (e.g. telephone recordings) to ensure compliance with internal policies and regulatory requirements, as well as to enable reviews or investigations by the intermediaries, their external auditors and regulators
The findings of the concurrent thematic review will form the basis for the HKMA and SFC to assess intermediaries’ compliance, and in the event of a breach, take regulatory action.
The SFC and the HKMA will also share the findings of the thematic review with the industry and consider the need for further guidance, where appropriate.
Transformation process
The announcement of the SFC-HKMA review on spread practices follows the release of a similar thematic paper by MAS (Monetary Authority of Singapore) in February, covering sales and advisor practices in private banking.
“This underscores the importance for private banks and wealth management firms to urgently ensure they have deployed the relevant pricing frameworks, disclosures and controls across all asset classes; especially so in the category of non-exchange traded products which typically apply a spread instead of commission charging,” says Prasanna Venkatesan, Partner within Synpulse in Singapore.
“As a result of both the MAS and concurrent SFC-HKMA thematic review on pricing practices, we expect to see the industry conforming to strict standards to be laid out in the thematic review results.”
According to Venkatesan, this transformation process by intermediaries may take place in the form of a strategic target operating model overhaul, IT infrastructure investments and deployment of additional control monitoring measures.
“Intermediaries that have not yet been deploying industry best practices are likely to conduct a review to understand the intricacies required for each product class,” he says.
In particular, Venkatesan highlights the need for intermediaries to automate surveillance of client communication channels, promote the right risk culture and governance, and ensure adequate structured documentation on pricing arrangements with individual clients.
