Hong Kong’s complex product regime is expected to shrink «reverse inquiry» business and move market share to big banks.
Hong Kong’s upcoming regulatory change requiring the classification of all products sold is set to virtually put an end to «execution-only» business for most but large banks will once again be the relative winners.
Whilst larger private banks have always had an obvious advantage in terms of the universe of markets and products covered, the playing field to secure most, if not all, transactions has technically been level – until July 6 when the Securities and Future Commission’s (SFC) new rules on «online distribution and advisory platforms» come into effect.
Risky Behavior
The private wealth management industry in Hong Kong is already well-accustomed to the KYC (know-your-client) and client suitability needs which the SFC requires to ensure that «the recommendation or solicitation for the client is reasonable in all the circumstances, having regard to information about the client of which the licensed or registered person is or should be aware through the exercise of due diligence».
Effectively, any engagement regarding an uncovered security or product that could even be remotely construed as active on the part of a relationship manager could be deemed risky behavior.
But the emergence of online trading by HNWIs (high-net-worth individuals) has led to a gap in the accountability of the sales process.
Smile as a Recommendation?
Whereas prior to the digital uptrend, orders were traditionally made through a relationship manager which would inevitably bring into the question the nature of these interactions and whether or not any statements could be interpreted as «recommendation or soliciation» (one unnamed investment advisor several years ago cynically asked if a «smile» could be viewed as a recommendation).
In contrast, disclaimers and checkboxes ubiquitous in the financial world online allow false or partial «reverse inquiry» transactions (also commonly referred to as «execution-only») to bypass the traditional compliance net.
Exploit a Loophole
«What would often happen is an RM (relationship manager) would push an uncovered product to a client but say that he or she would need to jump through hoops to successfully transact in the normal channel,» says a regional product head who wished to remain anonymous. «And then the client would be suggested to go online, click all the ‘I agree’ buttons and trade. This way, the RM does not need to go through the standard processes.»
Despite what appears to be attempts to exploit a loophole, the source notes that he does not observe any fundamentally unethical or risky behavior at a meaningful scale.
«The benefits of the traditional channel, namely the power of regulatory enforcement, is often communicated and clients are very much onboard with the explicit intent of securing an opportunity in a specific timeframe or not wanting to be outright unable to trade the product after being deemed unsuitable,» he added.
Scale is still king
Come July 6, the market will test its appetite for «reverse inquiry» business moving forward. In addition to basic considerations like demand size or margin, other less quantifiable factors such as contribution to relationship value – a key cultural factor to secure trust and future business, especially in the region – will be scrutinized as well. But regardless of the criteria, there is little doubt that larger banks will once again be relatively better positioned to withstand tightening.
Barring some very certain and very large ticket sizes, most bankers are not expected to even test appetite for these one-offs, be it for a new product, security or, most unlikely, a distribution agreement with a brand new asset manager. And on that assumption, larger banks are not only better positioned to receive more due diligence requests and attract more client assets but also at a more competitive rate and lower minimum amount due to economies of scale.
Costs Will Outweigh the Benefit
Although the SFC’s rules are broadly checkbox-based and relatively simpler to comply to compared to standard due diligence procedures, many believe the costs will almost always outweigh the benefits, effectively rendering any active pursuit of «reverse inquiry» business unworthy to most.
