Hong Kong’s markets watchdog has signaled its intent to turn the heat up on fund distributors by consulting on proposals that would provide more clarity around commission rates.

The move is seen as being in line with the global trend towards increased product disclosure, but has stopped short of moves to ban commissions seen in countries such as Australia, the Netherlands and the UK. Some industry observers suggest the approach taken by the Securities and Futures Commission may be the right one for Hong Kong.

The SFC's paper* covers two main areas, the first focusing on codifying market practices such as repos, custodianship of assets, liquidity risk management and disclosing leverage.

The second is of greater interest to Hong Kong’s fund distributors, as it targets transparency around the selling of funds to retail investors. The paper mainly advocates that fund distributors claiming to offer independent product advice cannot receive any fees for products provided. It also suggested that distributors disclose all fees being placed on products at the point of sale, and then annually.

“In Hong Kong, the vast majority of fund distribution is done via banks, but the new paper is trying to ensure that if you say you are independent then you have to be independent,” Sally Wong, chief executive of the Hong Kong Funds Investment Association, told AsianInvestor.

In line with best practice

Rolfe Hayden, a partner at law firm Simmons & Simmons in Hong Kong, said the suggested changes would help the SFC bring its rules into line with modern international practices.

The regulator has already been cracking down on cases of insufficient disclosure, he noted, citing the one-year ban imposed this week on Benedict Ku Ka Tat, a former employee of The Pride Fund Management.

Rolfe Hayden

It charged Ku under its current rules, but Hayden said the suggestions in the paper would make such steps much easier. In particular, a key part of the consultation paper suggests that parties claiming to be independent are not allowed to accept any commissions for selling funds.

While market participants have three months to offer their feedback to the paper, the SFC is very likely to introduce the suggestions. Hayden estimated that the watchdog implemented 95% of its consultation papers.

Retaining retrocessions

The SFC’s move to raise fund commission transparency is the latest in a line of pushes by regulators across the world to lift the veil over how distributors get paid for the funds they sell.

“There appears to be a somewhat coordinated approach by regulators globally, to review and ultimately make changes to the asset management and fund distribution industry,” said Stewart Aldcroft, head of trustee and fiduciary services for Asia Pacific and chief executive of Cititrust.

While the mooted regulatory changes would lift the lid on the commissions that distributors charge to retail investors, they are a lot less ambitious than steps taken in countries such as the UK, Australia, the Netherlands and Canada. In these countries, initial commissions and trail commissions (also known as retrocessions) for selling funds  have been or are in the process of being outlawed. Instead, investors agree on a “pay for advice” fee with the fund adviser in advance.

Sally Wong

“Rather than swinging to other end of pendulum and banning commissions altogether, the SFC seems to feel a better way is to increase transparency and make clear the roles played by all market players, and let investors make an informed decision,” said Wong of the HKIFA. “We will see how that pans out. All models have their own merits.”

The paper notes the potential for unintended consequences of a complete ban on commissions outright. “For instance, an 'advice gap' may have emerged in jurisdictions adopting a pay-for-advice model, where investors who are without the resources or unwilling to pay for advice could be left with no or very limited access to investment products,” the paper stated. Concerns over this gap led the UK's Financial Conduct Authority and Treasury to seek automated means to offer advice.

Aldcroft argued that the more modest route taken by the SFC was a constructive approach.

“My concerns are that the SFC must avoid making sweeping changes that will ultimately make it less attractive for banks, as the major distributor of funds, to do this business,” he noted. “That might lead to lower volumes, which is certainly not in the interest of fund managers.”

But while the suggestions in the consultation paper are relatively light-touch, Hayden said the regulator would keep an eye on what was becoming normal practice among other international financial centres and adjust accordingly.

“The SFC talks to other regulators in leading jurisdictions and is keen to be seen as a good global citizen,” he said. “I think it will continue [to want to do so].”

Commissions preferred

The approach to educate investors about commissions rather than banning them outright might better capture the current preferences of fund buyers in the territory.

Wong said the HKIFA was about to release a survey in which it had spoken to a large number of retail investors, to gain their views about being charged distribution commissions for funds they invest into, versus being charged a flat advisory fee and then receiving neutral advice about all products available.

Some of the responses surprised her.

“Investors in Asia do not really want to pay for advice, but prefer to pay by commission,” Wong noted. “We had some remarks by investors during an off-the-cuff discussion, in which they asked if they would need to trade more to justify paying for such advice.”

Again, the paper supports her view. “It was noted [in a survey conducted by the Financial Standards Board and market research firm GfK in 2015] that one of the top three barriers to financial planning is that Hong Kong consumers feel that the fees / costs charged for financial advice are not worth it,” the paper stated.

Instead of banning commissions to IFAs, some observers feel there are other areas that should be addressed by the SFC. Aldcroft argued the regulator should focus on liberalising its rules surrounding online funds, suggesting that it could offer local investors new avenues to buy funds – and stimulate the city’s robo fund adviser industry too.

“There is a clear need for the SFC to update their highly restrictive regulations on online fund distribution, which I hope will get included,” he said. “A few fund managers that specialise in this area have been unable to set up in Hong Kong because of the out-of-date regulations for this."

* The ‘Consultation Paper on Proposals to Enhance Asset Management Regulation and Point-of-sale Transparency’ is available on the website. The deadline for submissions is February 22, 2017.