Oversight April 2017 - SFC proposes further amendments to Professional Investor Rules

Introduction

On 01 March 2017, the Securities and Futures Commission (SFC) launched a consultation (Consultation) on proposed amendments to the Securities and Futures (Professional Investor) Rules (PI Rules). The PI Rules are subsidiary legislation promulgated under the Securities and Futures Ordinance (SFO). Specifically the PI Rules prescribe additional categories of persons who may be treated as “professional investors” for certain SFO purposes to those defined in Schedule 1 to the SFO.

Under the current professional investor regime in Hong Kong, professional investors can be broadly separately into two categories:

• „„those falling within paragraphs (a) to (i) of the definition of “professional investor” in Schedule 1 to the SFO – more commonly known as the “institutional professional investors”. These are mainly financial institutions regulated in Hong Kong and overseas, and
• „„those prescribed in the PI Rules – often referred to as the “high-net-worth professional investors”. These comprise individuals and different types of person such as corporates, trusts and partnerships which meet the criteria set out in the PI Rules.

The importance of the PI Rules and the definition of “professional investor” derives from the fact that many conduct related provisions of the SFO and the SFC’s Code of Conduct for Persons Licensed and Registered with the Securities and Futures Commission (Code of Conduct) include express exemptions for dealings by intermediaries and others with professional investors.

In the Consultation, the SFC proposes to amend the PI Rules. If adopted, these changes will result in both an expansion of persons who would qualify as professional investors under the PI Rules, and the forms of evidence that may be relied upon when assessing professional investor status under the PI Rules. The SFC says in the Consultation that the proposed amendments are intended to enhance market transparency and promote consistency in the application of the PI Rules. Although the changes proposed in the Consultation are an evolution and modification of the law as in place now, the existing PI Rules will be repealed and replaced by a significantly redrafted new set of PI Rules.

No changes are proposed to the definition of professional investor in Schedule 1 to the SFO itself. In addition these changes will not revise the Code of Conduct. The Code of Conduct regime applicable to professional investors has itself been revised in recent years – the most recent changes taking effect in 25 March 2016.

Existing PI Rules

Currently, under the PI Rules, professional investors include persons belonging to one of the following four categories of high-networth professional investors, namely:

• „„A trust corporation entrusted with total assets of at least HK$40 million (or the equivalent in foreign currency)
• „„An individual who, either alone or with his/her associates (defined in the PI Rules to mean spouse or child) has a portfolio of at least HK$8 million (or the equivalent in foreign currency)
• „A corporation or partnership with either a portfolio of at least HK$8 million (or the equivalent in foreign currency) or total assets of at least HK$40 million (or the equivalent in foreign currency), and
• „„A corporation the sole business of which is to hold investments and which is wholly owned by any of the persons falling within the foregoing three paragraphs above.

The PI Rules also set out certain methods and evidentiary requirements which may be used to ascertain the relevant assets and portfolio threshold.

A person must, to fall within the professional investor categorisation under the PI Rules, meet the financial threshold test as at the “relevant date”. This is defined as being, inter alia, in the case of an advertisement, invitation or document, the date on which it is issued or in the case of a cold call, the date of the call itself. “Portfolio” is defined in the PI Rules as a portfolio comprising securities, certificates of deposit issued by a bank or cash held with a financial institution, ie liquid assets. The threshold assessment cannot therefore include real estate such as a person’s home.

Under revisions to the PI Rules effective in 2011, the PI Rules permit what the SFC describes as a “principles–based approach” to be adopted where an intermediary needs to satisfy itself that an investor meets the relevant assets or portfolio threshold at the relevant date. This means that an intermediary can determine for itself how these thresholds are met provided, as the Consultation re-iterates, proper records of the assessment process are kept so as to demonstrate that there has been an exercise of professional judgment and a reasonable conclusion has been reached in the assessment of the threshold. 

Proposed amendment 1: Allowing aggregation of certain assets

In the Consultation, the SFC proposes to:

• „„Allow an individual to aggregate the portfolio, or share of the portfolio, of any corporation the principal business of which is to hold investments and which is wholly or partially owned by the individual at the relevant date when determining whether the individual meets the relevant portfolio threshold to qualify as a professional investor. The rationale behind this proposal is that it is considered common in Hong Kong for investors to use special purpose vehicles (SPVs) to hold assets and these may not be wholly-owned by the relevant individual, and
• „„Include an individual’s share of a portfolio held in an account jointly owned by the individual with other persons (including individuals, corporations and partnerships), not just associates, at the relevant date when determining whether the individual meets the relevant portfolio threshold to qualify as a professional investor.

The term “associates” is defined in the SFO to include, in brief, immediate family members and entities with which a person has a business relationship or existing agreement.

The proposals accordingly allow aggregation with a wider number of persons and would permit individuals to aggregate their share of assets held in SPV investment vehicles or in joint accounts with friends, siblings, parents or grandparents for the purposes of meeting the threshold. The amount or proportion to be aggregated i.e. the “share” owned or belonging to the individual will need to be worked out. This would presumably be on an equal basis with the other parties unless there is evidence or an intermediary is satisfied to the contrary.

Proposed amendment 2: Expanding the definition of corporations to qualify as professional

investors

The SFC also proposes to expand the categories of corporate professional investors to:

• „„Include any corporation the principal business of which at the relevant date is to hold investments, where the corporation is wholly-owned by one or more persons where each of them qualify as a professional investor (under the PI Rules or Schedule 1 to the SFO). This is intended to address the situation whereby companies or SPVs established for investment purposes have other businesses. Accordingly the business of such an investment vehicle does not solely have to be investment, and
• „„Allow a corporation to qualify as a professional investor if it wholly owns another corporation that qualifies as a professional investor under the PI Rules by meeting the assets or portfolio threshold. The SFC considers it sensible for holding companies which wholly own existing professional investor companies to be treated as professional investors themselves.

These proposals are logical and are merely an extension of the existing categories of professional investors.

Proposed amendment 3: Allowing alternative forms of evidence

The SFC proposes to specify alternative forms of evidence in ascertaining whether a person meets the relevant assets or portfolio threshold to qualify as a professional investor, namely:

• „„Public filings made pursuant to legal or regulatory requirements in or outside of Hong Kong
• „„Certificates issued by “custodians”, and
• „„Certificates issued by auditors or certified public accountants in respect of corporations, trust corporations and partnerships – these certificates are currently only acceptable for individuals.

These proposals would provide more flexibility for intermediaries and investors alike, compared to the forms of evidence required under the existing PI Rules, which are restricted to statements of accounts issued by custodians, most recent audited financial statements (in the case of trust corporations, corporations and partnerships only) or certificates issued by auditors or certified public accountants (for individuals only).

A custodian for those purposes is broadly defined in the PI Rules and means being an entity whose principal business is custody or any financial institution inside or outside Hong Kong which holds client assets on trust or by contract.

Implications for fund managers

The proposed amendments are intended to incorporate into the PI Rules specific modifications that the SFC indicates that it previously granted to certain intermediaries on application. These changes will not radically change the PI Rules. In particular it is noticeable that no changes are proposed to the monetary thresholds or the definition of what constitutes a portfolio.

Offers of interests in non-SFC registered funds, under the existing placement regime, are permitted if the interests are or are intended to be disposed of only to professional investors. The proposed amendments, if implemented, will allow fund managers of non-SFC registered funds to approach a greater number of potential investors, as the number of people who will qualify as professional investors will increase.

Intermediaries should note that notwithstanding the proposed amendments to the PI Rules, their obligations to comply with
the requirements set out in the Code of Conduct (such as the need to ensure suitability and carry out assessments on corporate professional investors) are not changed.

Comments on the Consultation to the SFC ended on 03 April 2017. 

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