Since the initial monetary benefit requirements introduced by the Hong Kong regulators, several other circulars have followed that have clarified the regulatory expectations on how the Code of Conduct should be interpreted. The Hong Kong Monetary Authority and the Securities and Futures Commission announced this May a “Concurrent SFC-HKMA thematic review of spread charges and other practices,”1 aiming to explore the topic with various financial institutions in the second semester of 2020.
Based on this, Synpulse expects the regulations around disclosing quantifiable monetary benefits to tighten and the scope of the regulation to increase to potentially cover over-the-counter (OTC) structured products and derivatives as well, this time more explicitly. From our experience, these transactions can account for up to 20% of transactions for some private banks and thus provide a significant revenue stream. As such, it is time for the industry to increase transparency around pricing and fee practices.
Regulatory Focus and Current Market Standard
The requirement to disclose quantifiable monetary benefits received by the bank from a trade is described by the Securities and Futures Commission Code of Conduct, section 8.32. The section is further split into explicit and non-explicit benefits, and describes two types of monetary benefits that must be disclosed:
- Explicit remuneration arrangements; and
- Trading profit made from back-to-back transactions.
The latter refers to trading profits made without taking on market risk, whereas the prior, "explicit remuneration arrangements," refer to the following case where disclosure must be made:
Where a licensed or registered person and/or any of its associates explicitly receives monetary benefits from a product issuer (directly or indirectly) for distributing an investment product.
The section focuses heavily on the setup of a product being first issued, and then distributed, a key distinction that allows banks to not disclose quantifiable monetary benefits for many OTC transactions of structured products, derivatives, and other customised products or contracts. This category includes many products of the highest risk classes, including accumulators of different underlying, as well as derivatives and various options structures.
In terms of implementation, banks focus on the second part of the Code of Conduct paragraph 8.3:
The licensed or registered person should disclose the monetary benefits that are receivable by it and/ or any of its associates as a percentage ceiling of the investment amount or the dollar equivalent.
The usual practice in the market is to provide a standard disclosure for monetary benefits that the bank may receive "up to 1%" in benefits as part of the client on boarding process and refer to this generic fee in most cases. If the monetary benefits receivable exceeds this pre-disclosed 1%, then the specific amount is disclosed instead.
Towards transparency and better practices
With Hong Kong Monetary Authority placing continued attention on what it sees as complex products, we see it likely that the regulator will, in the future, take a harsher stance on the disclosure of monetary benefits for OTC structured products and derivatives. HKMA and SFC are conducting a joint review of various financial institutions’ practices in implementing this part of the Code of Conduct at the time of writing, H2 20203. The conclusions and findings will provide clarity on the regulatory stance, and should any issues around processes, controls, systems, governance or misconduct be discovered around OTC structured products or derivatives, it is possible that we will soon see additional clarifications by the regulator confirming the applicability of Code of Conduct section 8.3 to these products as well.
Once the review is completed and its findings published, we see best practice in the area of monetary benefits moving towards increased transparency. Empowered by robust processes, systems and a leading controls framework, the leading banks may soon implement disclosures of monetary benefits calculated specifically for each transaction at point-of-sale.
How Synpulse can support your transition
We can support you with regulatory change management across the full lifecycle, including staying on top of best practices, comparing your approach to industry leaders, and charting the way forward on how to address concerns, close gaps, or push the envelope in regulatory compliance with the support of technology.
1. Concurrent SFC-HKMA thematic review of spread charges and other practices ― May 2020
2. Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission ― June 2020
3. Concurrent SFC-HKMA thematic review of spread charges and other practices ― May 2020
