Hong Kong SFC consults market on proposed changes

Introduction

On 01 March 2017, Hong Kong's Securities and Futures Commission (SFC) issued the Consultation Paper on the Proposed Amendments to the Securities and Futures (Professional Investor) Rules (Consultation Paper). Market participants and interested parties are invited to submit written comments on this Consultation Paper by 03 April 2017.

The SFO proposes to amend the Securities and Futures (Professional Investor) Rules (PI Rules) for:

1. allowing an individual's share of joint accounts with non-associates and assets held in investment vehicles owned by individuals to be counted in ascertaining whether the monetary threshold to qualify as a professional investor is met
2. expanding the definition of corporations to qualify as professional investors, and
3. allowing alternative forms of evidence for demonstrating qualification as a professional investor.

Background

Professional investor exemption

The Securities and Futures Ordinance (Cap. 571) (SFO) provides an exemption that market practitioners can use in respect of “professional investors” to avoid legal restrictions that the SFO imposes on:

• the issuance of advertisements, invitations or documents in relation to securities, regulated investment agreements and collective investment schemes
• the making of unsolicited calls, and
• the communication of an offer in relation to securities.

Additionally, the offering of any shares or debentures to professional investors is not subject to the prospectus regime under the Companies (Winding Up and Miscellaneous Provisions) Ordinance (Cap. 32). In other words, a prospectus authorised by the SFC is not required.

Definition of “professional investor”

There are two types of “professional investors” under the SFO:

• entities set out in paragraphs (a) to (i) of the definition of “professional investor” in Part 1 of Schedule 1 to the SFO (eg banks and insurance companies), and
• high net worth professional investors set out in the PI Rules.

The Consultation Paper primarily relates to high net worth professional investors, of which there are currently four types:

1. any trust corporation with total assets of not less than HK$40m in any currency
2. any individual who (either alone or with his/her spouse or children on a joint account) has a portfolio of not less than HK$8m in any currency
3. any corporation or partnership with either:
   1. a portfolio of not less than HK$8m in any currency, or
   2. total assets of not less than HK$40m in any currency, and
4. any corporation the sole business of which is to hold investments and which is wholly owned by a professional investor described in a, b or c above.

Proposals

Modifications to the relevant requirements subject to the proposed amendments have often been granted by the SFC upon application by some intermediaries under section 134 of the SFO in order to aid in the efficiency of their operations and clients without compromising investor protection. The SFC has granted around 40 subsisting modifications to date, which are published on its website. The proposed amendments would incorporate the modifications commonly granted by the SFC that have become standardised over time with a view to enhance transparency and promote market consistency.

The SFC aims to provide more practical flexibility to both intermediaries and their clients by amending the PI Rules principally to expand the categories of professional investors and to refine the associated evidential requirements. The three principal heads of the proposed amendments are as follows:

Allowing the aggregation of share of joint accounts with non-associates and assets held in investment holding vehicles

In ascertaining whether an individual meets the monetary threshold to qualify as a professional investor, the PI Rules currently allows the aggregation of an individual’s share of joint accounts with associates (ie his/her spouse or any child) (ie type (b) above) and assets of a corporation wholly owned by an individual with the sole business of holding investments (ie type (d) above).

Some market participants have expressed that the current requirements have made it difficult for some individuals to qualify as professional investors as their joint accounts with non-associates and assets held in investment vehicles would not be counted towards ascertaining whether individuals meet the monetary threshold, which are common structures used for investment holding.

The proposed amendments to the PI Rules would expand the scope in which individuals can meet the monetary threshold to qualify as professional investors:

• For joint accounts, an individual would be allowed to aggregate his/her share of joint accounts with other persons (including individuals, corporations and partnerships) who are not associates (ie his/her spouse or any child).

• For investment holding vehicles, an individual would be allowed to aggregate a share of the portfolio of a corporation the principal business of which is to hold investments and which is wholly or partially owned by him/her at the relevant date when determining whether he/she meets the relevant portfolio threshold to qualify as a professional investor. This would provide broader application as compared to currently requiring a corporation the sole business of which is to hold investments to be wholly owned by the individual.

Qualification by corporations as professional investors

The PI Rules currently allows a corporation the sole business of which is to hold investments and which is wholly owned by one or more of the first three types of high net worth professional investors (ie types (a), (b) and (c) above) to qualify as a professional investor itself (ie type (d) above).

The proposed amendments would expand the categories of professional investors to include corporations which have investment holding as their principal (rather than sole) business and are wholly owned by one or more professional investors (which would apply to an expanded scope of individuals and corporations who are professional investors themselves and several other additional types of professional investors specified in Part 1 of Schedule 1 to the SFO), as well as corporations which wholly own another corporation that itself is a qualified professional investor.

Evidential requirements to prove professional investor status

The PI Rules currently sets out specific evidential requirements to ascertain the relevant assets or portfolio threshold for the first three types of high net worth professional investors (ie types (a), (b) and (c) above). Some market participants have expressed that these evidential requirements make it difficult in practice to classify clients as professional investors. As a result, some intermediaries have not been able to take advantage of the professional investor exemption in respect of such clients.

The proposed amendments would permit intermediaries to accept alternative forms of evidence demonstrating a client’s qualification as a professional investor. It would permit the use of public filings made pursuant to legal or regulatory requirements in Hong Kong or elsewhere and certificates issued by custodians as two new alternative forms of evidence for ascertaining qualification as a professional investor. The use of certificates issued by auditors or certified public accountants for ascertaining qualification as a professional investor currently available for individuals, which is the currently acceptable alternative form of evidence under the existing PI Rules, would also be expanded to cover corporations, trust corporations and partnerships.

Responses to the Consultation

The Consultation Paper poses five questions to the public in relation to the proposed amendments to the PI Rules. Parties who wish to respond should submit written comments to the SFC by 03 April 2017.

We expect positive market reaction to the proposed amendments as they seek to strike a balance between reflecting the views and business needs of intermediaries and their clients with regard to common practices and investment structures, and implementing investor protection measures.

Intermediaries should expect to see an increased number of clients that meet the relevant requirements and qualify as professional investors, and they would be allowed to obtain and maintain appropriate evidence of demonstrating qualification as professional investors in practice.

We also expect, as the SFC has indicated, that the proposed amendments will facilitate and encourage the participation of corporations in private placement activities in capital markets.