The Financial Services Commission and the Financial Supervisory Service introduced a set of measures intended to prevent mis-selling of highly complex financial investment products on February 26.
Background
In the aftermath of large-scale losses incurred to investors regarding the sales of Hong Kong index-linked ELS (equity-linked security) products by domestic financial companies in early 2024, the FSS prepared the guidelines for compensations on March 11, 2024, and the banking sector’s compensation programs have been in progress. As a result, the numbers of compensations being paid out to investors, of cases in which investors have agreed to the terms of compensation, and of the ratio of compensation amount on average have all continued to increase between the end of June 2024 and the end of 2024.
On-site inspections conducted by the FSS revealed that most bank branches had no clear distinction of counters between the ones selling highly complex financial investment products and those handling ordinary deposit-taking functions. As a result, great numbers of consumers could have been misled into believing that these highly complex financial investment products were principal-guaranteed products. Moreover, their sales practices revealed that financial companies placed a higher priority on sales performance rather than on the compliance of sales regulations. As a consequence, there was inadequate information provided to investors regarding the risk associated with highly complex financial investment products, and the sales of ELS products took place without the establishment of sufficient internal control mechanisms designed to prevent mis-selling and ensure protection of consumers.
Against this backdrop, the FSC and the FSS have prepared measures to prevent mis-selling of highly complex financial investment products after having a series of meetings with related experts and industry groups.
Key Measures
a) Making improvements to financial investment products’ sales channels at banks
First, in order to help increase consumer awareness on financial investment products and ensure responsibility from banks in their sales practices, the proposed plan will bring about improvements to financial investment products’ sales channels at banks.
Previously, the sale of highly complex financial investment products including ELS was possible from all bank branches. Moreover, there existed no strict separation of counters at banks that handle deposit-taking functions from those selling highly complex financial investment products. As a result, it was possible that a consumer visiting a bank to attend to his or her savings account could receive an investment recommendation to sign up for a highly complex financial investment product from the same teller at the same counter.
To improve upon this situation, the sale of ELS products at banks will be allowed only at certain qualified bank branches that are equipped with an adequate level of consumer protection mechanisms. These qualified bank branches need to have a physically separated office space exclusively handling the sale of ELS products—for instance, with a distinct entrance door or through separation of floor levels. In addition, the sale of ELS products should only be carried out by qualified sales personnel equipped with appropriate training and certification under related regulations and prior experience of at least three years in the same field.
There will also be improvements regarding the sales channels for other types of highly complex financial investment products such as highly complex public offering funds. These investment products can be sold at both regular branches and qualified branches. However, the counters handling the sale of these investment products will need to be identifiably distinguishable from those handling ordinary deposit-taking and/or lending functions—for instance, through a counter partition or display of a different color on customers’ waitlist—to make sure that consumers are able to clearly see and understand the distinction.
In the meantime, these “sales channel” requirements will also apply to the branches that house both a bank and its affiliated securities firm under the same financial group. Thus, the sale of highly complex financial investment products by bank employees at these jointly housed bank branches will be allowed exclusively at investment counters separated from those handling ordinary deposit-taking and/or lending functions. Moreover, to prevent excessive solicitation practices, bank employees’ marketing activities regarding the sale of highly complex financial investment products will not be reflected in their key performance index (KPI).
b) Improving rules and practice to ensure that consumer protection principles are effectively observed
To encourage financial companies to place consumer interest before their own profit, financial companies will be required to prepare standards for ensuring consumer protection and incorporate these principles into their internal control standards in accordance with the Act on Corporate Governance of Financial Companies.
In addition, by strictly adhering to the “suitability and adequacy test,” financial companies will need to look into all six required criteria when screening investors’ information and their risk appetite. When evaluating an investor’s risk appetite toward highly complex financial investment products, financial companies will need to make use of both scoring method and factoring-out method in a balanced way.
Financial companies will also need to specifically determine key sales target groups for individual products and should not engage in the solicitation of customers who fall outside of their target groups. If a customer—who is deemed to be unsuitable for investing in a certain highly complex financial investment product—still wishes to subscribe to that product, financial companies should clearly indicate and inform in a written document the unsuitableness and inadequateness of purchasing that particular product to the customer. In this case, financial companies will also need to keep documents showing that there were no solicitation activities.
Moreover, considering investor biases and to encourage consumers to practice caution when signing an investment agreement, key information detailing specific types of consumers deemed to be unsuitable for investing in highly complex financial investment products and the potential risk of investment losses and the actual cases where investment losses have occurred will be provided on the very top of product description documents in a language that is easy to understand for ordinary consumers. In addition, to make sure that consumers are able to immediately have an understanding about the nature of the financial product that they are about to subscribe to, these investment products should clearly spell out “highly complex financial investment product” in a way that consumers can easily identify. Consumers will also be provided with easy-to-understand video clips via mobile links or QR codes during the subscription process and cooling-off period to make sure that they have a clear understanding about the complex structure of particular investment products and the potential of asymmetrical loss and gain.
c) Ensuring the establishment of internal control mechanisms designed to prevent
mis-selling and strengthening supervision
The proposed measures will redesign the current key performance index (KPI) applied on financial investment products in ways to shift the focus away from short-term sales performance to make it more centered on consumer interest. In this regard, there will be best practice examples and guidelines provided to financial companies to foster an organizational culture where consumer interest is prioritized by financial companies.
In addition, the FSS will conduct periodic inspections on how financial companies are adhering to the “suitability and adequacy test” principles to closely monitor trends in the sales of financial investment products and strengthen supervision. In the process, the FSS will seek to share best practice cases and expand the sample base for mystery shopping to enhance quality management afterwards.
Considering the investment risk of individual investment products, financial companies should periodically reassess their sales limits (for instance, every month) and select specific elements requiring a close monitoring to ensure a thorough review by their own consumer protection departments.
Financial companies and the financial authorities plan to strengthen monitoring on a quarterly basis over abnormal movements in the market, such as a herd behavior on particular products, spread of investment risk, and a plunge in underlying asset prices. When deemed necessary, the financial authorities may take preemptive actions for inspection and supervisory measures (consumer alert, etc.).
Further Plan
Among the proposed measures intended to prevent mis-selling of highly complex financial investment products, the financial authorities will seek to immediately implement the ones requiring no revision to rules and regulations, while pursuing amendments to legislations and other subordinate rules within this year.
* Please refer to the attached PDF for details.