Alert

Who does this affect?

All participants involved in the issuance of structured products in Hong Kong.

What do you need to do?

Read the proposals and give us your input so that we can respond to the SFC on your behalf.

Author
Richard Mazzochi  (馬紹基)
Partner

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Richard Mazzochi
(馬紹基)
Partner
T +852 3443 1046

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Hong Kong
Minny Siu  (蕭乃瑩)

Beijing
David Olsson  (沈文)

London
Rowan Russell  

Sydney
Scott Farrell  
Martin James  

Melbourne
Ian Paterson  

Perth
John Naughton  

Brisbane
Berkeley Cox  

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Important further changes to the offering of structured products have been proposed by Hong Kong’s Securities and Futures Commission (SFC). The proposals set out in the “Consultation Paper on Possible Reforms to the Prospectus Regime in the Companies Ordinance and the Offers of Investments Regime in the Securities and Futures Ordinance” (Paper) will eliminate a number of channels that are currently used to distribute structured products on an “exempt” basis in Hong Kong.

Overview of key practical outcomes

The proposals apply to all unlisted structured products offered to the public (other than deposits linked to foreign currency or interest rates). The Paper does not affect listed structured products such as warrants or CBBCs.

The key proposed outcomes are that:

• The exemption for structured notes where the minimum consideration paid is not less than HK$500,000 will not apply. This means market access products such as participation notes and equity linked notes can only be sold on a private placement basis if the offer satisfies an exemption available under the Securities and Futures Ordinance (SFO).

• Licensed intermediaries may not issue offering materials for unlisted structured products without the SFC’s prior approval.

• Publicly offered convertible and exchangeable bonds and regulated investment agreements (such as contracts for difference) will be treated as structured products, which means the more stringent “know your client” procedures will apply to the sale of such instruments.

Background

The Paper follows the release of another paper (September Paper) a few weeks earlier which proposed wide-ranging changes to the way that unlisted structured products are manufactured and distributed. Please see our previous alert: Reform of the sale of unlisted structured products in Hong Kong - the devil is in the detail - 29 September 2009.

The Paper proposes changes to:

• the Companies Ordinance (CO) which regulates the offer of shares and debentures (including structured notes); and

• the SFO which also regulates the offer of shares and debentures and other “securities” (including equity-linked investments and deposits).

The CO and SFO regime have different requirements (for example, with respect to the basis on which liability is imposed for the accuracy of offering material).

The SFC proposes that all structured products (including structured notes) be regulated by the SFO and governed by a new Handbook which contains all the details of the content of offering documents and the after-sale obligations of issuers.

The news is not all good

Shifting the regulation of structured products from the CO to the SFO is welcome. It means the “clunky” rules set out in the CO including prospectus liability, advertising and registration of the prospectus will not apply.

But the Handbook will apply, which means:

• all structured product advertising will need to be approved by the SFC; and

• the list of items that the CO currently requires to be disclosed in a prospectus will be restated and supplemented in the Handbook.

Key concepts

The SFC’s proposed amendments to the CO and SFO are fairly simple:

• the CO will not apply to “structured products”;

• the SFO will apply to “structured products” which means an instrument the pay-off of which is defined by reference to changes in the value of another asset or reference point such as shares, commodities or interest rates;

• structured products will be “securities” meaning all the regulatory requirements of the SFO will apply;

• a “regulated investment agreement” will be a structured product.
  The SFO treats regulated investment agreements separately to securities under the current regime. This causes difficult interpretation questions for products such as equity linked investments which usually satisfy the definition of “security” as well as “regulated investment agreement”. The proposal is to remove all references to regulated investment agreements other than as a type of structured product. Issuers of regulated investment agreements will now need to be licensed by the SFC.

• a “floating rate note” is not a structured product;

• SFC authorisation is not required in respect of a “currency-linked instrument” or “money market instrument” issued by authorised financial institutions which mean instruments where “all” the amounts due under the instrument are payable by reference to changes in currency or interest rates (respectively), and

• some provisions of the CO will continue to apply to structured notes - for example, a register of debentures must be kept, debenture holder meetings must be held and trustees may not contract out of certain types of liability.

Existing CO exemptions will not apply

None of the exemptions currently available under the CO for structured notes will apply to structured products. In particular, two clear safe harbour will not be available:

• Where the minimum amount paid for a structured note is not less than HK$500,000. This exemption is relied upon extensively for sales of structured notes through private bank networks.

• The proposal to remove the minimum denomination exemption, when read together with the changes proposed in the September Paper, means:

• Offers made to no more 50 persons. The removal of this safe harbour under the CO needs to be examined against the requirement under the SFO that SFC approval is only needed for offers made to the “public”. The concept is unclear but is commonly understood by the industry (based on the previous CO regime) to mean that offers made to not more than 25 investors do not need approval. That analysis is narrower, and less clear, than the express “50 person” exemption under the CO.

The removal of these exemptions means that, unless an exemption under the SFO is available, SFC approval will be required for any offering material that might previously have been exempt as a “private placement”.

Conclusion

The SFC’s proposed changes mean greater SFC involvement in the sales of unlisted structured product that would previously have been exempt under the CO because of the minimum denomination exemption. SFC approval will continue to be unnecessary for offering documents given to professional investors, which is a much narrower target audience.

Mallesons Stephen Jaques is ready to respond to any questions and will be pleased to join with clients in responding to the Paper.