Alan Ewins highlights the potential for high net worth individuals in Asia with a special focus on Hong Kong in the Chinese year of the dragon.
High net worth (and ultra-high net worth) individuals and families in Asia have assets worth in the region of US$10.8 trillion[i]. Quite a source of allure for the legions of private bankers and wealth managers eager to capitalise on the opportunities for business and business growth, given that wealth management is one of the relatively few brighter spots in the current troubled financial markets.
Private wealth clients, including family offices, are keen to explore the possibilities of adding to those assets. They have an appetite to go beyond mere deposits (given the negligible interest rates) and (relatively safe) money market funds, and they continue to look for more structured means of investing to provide the chance for higher returns.
So, a combination of treasure, typically more adventurous clients and bankers and wealth managers hunting for profit sets the scene for an epic quest. In this case, the Dragon at the heart of the treasure has many faces, including fierce regulators, booby-trapped regulations and unforgiving investors (armed with litigators and the threat of reputational injury).
This article, using Hong Kong as the primary jurisdiction to consider, but with an eye to the rest of the region, is designed to tease out those issues, to map out the landscape for the private wealth industry over the incoming Chinese Year of the Dragon.
Fierce Regulators, Wielding Mighty Claws
Investor protection is at the heart of the Securities and Futures Commission's and the Hong Kong Monetary Authority's mandate in Hong Kong. This has led to a major re-vamp of the Hong Kong market in terms of sales of investment products, particularly structured products to retail customers. That begs the questions touched upon in the next section of this article as regards the differences between ‘retail’ and ‘professional’ (sophisticated) investors, who are viewed as needing a lower level of protection than the general public.
The single biggest problem facing private wealth managers in the present environment, and the main thrust of this article, is determining exactly how to treat their clients in terms of ‘business conduct’.
Regulations in Hong Kong have come under close scrutiny and have been subject to significant changes in terms of how investment products can be sold to investors, including the information to be provided, and the mechanics of sale. Those matters are fundamentally affected by whether the client is perceived as a ‘professional investor’ or as ‘retail’.
There is no separate designation for a ‘private wealth client’ or equivalent for the purposes of the securities and futures legislation. There is, however, a concept of a ‘professional investor’ at the level of selling products and also how such clients are treated for business conduct purposes. Also, there is a category of ‘private banking customer’ under the Hong Kong Monetary Authority regime, pursuant to a circular. The path to fools' gold rather than the Dragon's hoard.
‘Professional investors’ are those individuals with at least HK$8 million in assets; and corporates and trustees with at least HK40 million - in either case, the equivalent in another currency is fine. This counting of gold was until recently subject to rigid documentation requirements, including an auditor's certificate. As a result of changes to the rules, that has become a more relaxed regime, allowing more discretion to the institutions as regards how they assess the relevant asset levels.
Hong Kong only recently escaped from that relaxation being coupled with a harsh tightening, designed to provide statutory backing to certain code of conduct requirements, including a minimum number of trades before someone could be treated as a ‘professional investor’. Happily, that did not come to pass.
Why Does it Matter?
Being able to treat a client as a professional investor allows an institution to fall outside the public offering requirements under the Hong Kong regime in relation to securities, funds and structured products, so that it becomes possible to advertise products, including more exotic products, to clients without the need for prospectuses, SFC authorisation of selling materials, etc.
But it does not end there. Let us assume that the client being pursued by an institution falls within the scope of professional investors. The next level down is how that professional (ie, the private wealth client) can be treated in terms of business conduct by the institution.
For professional investors who are not bank customers, they need to go through a range of compliance hoops before they are treated as professional investors for the purposes of the conduct rules. That includes an assessment of their objectives, etc, explaining the protections that they will miss out on (which include complex suitability tests in relation to derivatives), and they are required to sign off on their approval of such treatment. Often, private wealth management clients prefer not to sign such documentation, either because of the nature of their ‘personalised’ and intended reduced hassle relationships with bankers etc, or because they object to losing the protections. Without the sign-off, the client must be treated as retail, with all the additional compliance issues that creates, even where the client is a billionaire and almost certainly a sophisticated investor at some level.
In terms of day-to-day client management, there is in any event a limited recognition of how different types of client - retail, private wealth, institutional or corporate banking client - should be differentially treated. Private wealth clients, arguably, fall into a no-man's land between the highly restricted retail market and institutional clients.
Even worse, ‘private banking customers’ of banks are those who are not ‘retail’, and indeed are not corporate customers, sole proprietors or partnerships. Private banking customers are those with a personalised banking relationship with a bank, who receive personalised banking services or portfolio management services, and have assets under management of at least US$1 million (that is, equivalent to the individual ‘professional investor’ limit above, but with the extra features of this relationship). Anyone not falling within this inner circle of banking customers is treated as retail and entitled to an important facts statement, setting out the basics of a product, when marketed to by his private banker.
All of this seems more in the context of a Hydra rather than a Dragon, given the multi-headed nature of the regime.
Many wealth managers have simply thrown up their hands and decided to treat everyone as retail, given the challenges of working through the maze of requirements to categorise customers.
While this has the attraction of relative simplicity, it does mean that an opportunity to differentiate the treatment of customers at a practical level is potentially lost. That may be seen as a good result for regulators, probably less so for the attractiveness and richness of the Hong Kong market place.
Happily, this issue is starting to be tackled more firmly in Hong Kong, and the outcome of various industry initiatives and discussions with regulators will (should) have a profound effect on the nature of regulation of the industry.
It should be noted that Singapore has already put in place a code of conduct for private banking – a statement of intent in the ongoing rivalry in the two jurisdictions for the crown of heavyweight private wealth centre in Asia. That code is non-statutory and indeed non-binding, and is at a broad, self-regulatory level not dissimilar in many respects to the present Hong Kong code of conduct for intermediaries. Hong Kong will need more.
Gone are the days when private wealth clients are prepared to absorb heavy losses without too much protest. The Lehman debacle, in the context of retail investors, has provided a platform for complaints which has raised the likelihood of client pursuit, particularly for mis-selling going forward. More and more clients are minded to adopt an aggressive approach to their private wealth managers, using techniques such as complaints to regulators, the threat of potential reputational damage for the managers, and ultimately the threat and fact of litigation, sometimes as a negotiating tool and sometimes as a full-on means of seeking redress for alleged wrongs.
The Ultimate Prize?
It will be important in the Year of the Dragon and beyond to come to grips with the issue, particularly in Hong Kong, of how the private wealth management industry should be regulated. This links into a hard look to be taken as regards how ‘professional’ or ‘sophisticated’ investors need to be classified (sometimes, in other jurisdictions, referred to as ‘qualifying’ or ‘accredited’ investors), and how they should be layered as regards the place of a private wealth client in the investor Universe. Retail as the most protected species, private wealth clients (and indeed, separately) large and very large corporates, and then institutional investors, all with clear water between the ways in which they are identified, classified and treated at a day to day operational level. The unsatisfactory lacunae and differential interpretation of ‘professionals’ could be addressed and clarified at the same time, to arrive at a more integrated approach to this important issue. It would not so much be a slaying of the market Dragon, more a chance to increase the size of his gleaming hoard. A holistic package may well prove to be the stuff of myth and legend, rather than reality.
[i] Source: Asia Pacific Wealth Report 2011
Alan Ewins Alan Ewins, a partner in Allen & Overy, experience includes advising numerous financial institutions on a wide range of product, risk management and compliance issues, on the regulatory aspects of sales and purchases of companies and businesses, and on establishing and offering interests in collective investment schemes. Alan also works closely with Allen & Overy's regulatory disputes and derivatives teams, particularly in Hong Kong, in the financial services area.