Following the regulatory changes in 2016 that increased suitability requirements on licensed persons when soliciting or recommending investment products to clients, the Hong Kong Securities and Futures Commission (SFC) has on 23 December 2016 issued two sets of Frequently-Asked-Questions (FAQs) to clarify and provide further guidance to the industry on meeting the suitability obligation.

The first set of FAQs on Triggering of Suitability Obligations clarifies the circumstances under which the suitability obligation would apply.  The second set of FAQs on Compliance with Suitability Obligations by Licensed or Registered Persons provides further guidance on the SFC’s expectations on satisfying the suitability obligation.

Please refer to our legal update for further information:

Further to the Shanghai-Hong Kong Stock Connect announced in 2014, in August 2016, a good two years later, it was jointly announced by the China Securities Regulatory Commission (CSRC) and the Hong Kong Securities and Futures Commission (SFC) that the Shenzhen–Hong Kong Stock Connect will soon be implemented.  It is anticipated that the Shenzhen-Hong Kong Stock Connect will be launched in November 2016.

Expanded universe of stocks for cross-market access

Stock Connect refers to the program that allows mutual stock market access between Mainland China and Hong Kong, whereby Mainland investors may access eligible Hong Kong stocks within scope through their domestic Mainland securities firms, while Hong Kong investors may access eligible Mainland stocks within scope through Hong Kong brokers. Hong Kong investors already able to access selected stocks listed on the Shanghai Stock Exchange under the Shanghai-Hong Kong Stock Connect will now also have access to selected stock lists on the Shenzhen Stock Exchange (SZSE) through the Shenzhen-Hong Kong Stock Connect.

The Shenzhen-Hong Kong Stock Connect will expand the universe of Mainland stocks that may be accessed by Hong Kong and international investors through the Hong Kong Stock Exchange, in particular eligible constituent stocks of the SZSE Component Index and SZSE Small/Mid Cap Innovation Index.  To be eligible, relevant constituent stock should have a market capitalization of RMB6 billion or above.  All SZSE-listed shares of companies which also has H-shares listed in Hong Kong would also be within scope.   On the other hand, Mainland investors will be able to access constituent stocks of the Hang Seng Composite LargeCap Index and Hang Seng Composite MidCap Index, any constituent stock of Hang Seng Composite SmallCap Index with market capitalization of HK$5 billion or above, and shares of all companies with both listed H shares and A shares.

ChiNext access restricted

However, while the range of accessible stocks have broadened for investors’ cross-market access, the regulators have stipulated that, for the Northbound link, at the initial stage, only institutional professional investors as defined under Hong Kong law and regulations will be able to invest in shares listed on the ChiNext Board of SZSE.

The restriction that only institutional professional investors may access ChiNext stocks may be considered to be in line with the SFC enhanced investor protection measures including around increased regulatory requirements around suitability of investments and financial products for investors, which may now be exempted only for institutional professional investors or corporate professional investors that satisfy relevant conditions under a designated assessment of investment decision-making process and investment personnel.  The definition of “institutional professional investors” as defined in the Securities and Futures Ordinance (Cap 571) (SFO) covers mostly regulated financial institutions such as licensed investment intermediaries, banks, insurance companies, central banks.  Collective investment schemes authorized by the SFC under Section 104 of the SFO (SFC Authorised Funds), registered schemes or constituent funds under the Mandatory Provident Fund Schemes Ordinance (Cap 485) (MPF Schemes) and registered schemes under the Occupational Retirement Schemes Ordinance (Cap 426) (ORSO Schemes).

Accordingly, investors who are not “institutional professional investors” under Hong Kong law and regulations and initially unable to access ChiNext stocks under the Shenzhen-Hong Kong Connect may only have exposure through SFC-Authorized Funds.  Investment by MPF Schemes in Mainland securities are limited to 10% of the scheme’s net asset value.

SFC Updated FAQ re Shenzhen-Hong Kong Connect

On 25 October 2016, the SFC updated question No. 19 under its “Frequently Asked Questions on Post Authorization Compliance Issues of SFC-authorized Unit Trusts and Mutual Funds” (SFC’s FAQ) regarding disclosure and approval requirements for participation in Stock Connect, to include Shenzhen–Hong Kong Stock Connect within scope.  Details are set out in our latest publication:

自内地与香港基金互认安排（“基金互认”）于2015年7月1日起正式实施至今，已有多达40余只内地基金成功南下获得香港证监会认可于香港市场公开销售。按照基金互认的相关规定，内地基金在获得香港证监会认可后（“内地互认基金”），除须符合相关内地法律法规及基金合同的要求外，还须遵守香港证监会不时颁布的有关内地互认基金获认可后的持续合规要求以及基金于香港销售方面的要求。下文就内地互认基金获香港证监会认可后的持续合规问题，从持续信息披露、基金销售文件更改以及基金广告/推广材料等多方面进行分析和阐释:

经济合作与发展组织（经合组织）就政府间自动信息交换（自动信息交换）引入的共同报告准则（共同报告准则）是一项重大举措，可能引起金融行业的范式转变。

继《2016年税务（修订）（第3号）条例》刊登宪报并于2016年6月30日生效后，共同报告准则将很快在香港实施。自2017年起，香港的金融机构及金融中介机构将承担法律义务向香港税务局（税务局）报告须申报人士的财务账户，并且须于下一年度5月31日（即2018年5月31日）之前向税务局作出首次报告。香港税务局将于2018年年底前基于互惠原则与相关司法辖区进行首次自动信息交换。

据税务局认为：“在自动信息交换准则下，金融机构须根据尽职审查程序识别须申报税务司法辖区的税务居民所持有的财务账户。金融机构须收集此等账户的须申报信息，并向本局提交相关信息。本局将每年与自动信息交换伙伴司法辖区的税务机关交换信息。”

自动信息交换规定将涵盖属“须申报司法辖区”（即香港已与其签订自动信息交换安排的司法辖区）的税务居民的个人。如账户持有人并非属于与香港签订自动信息交换协议的司法辖区的税务居民，则金融机构毋须申报有关账户的信息。

一般而言，一名个人是否属一个司法辖区的税务居民，要根据该司法辖区的税法确定，并且典型地要考虑该人士实际身处或逗留于某地（例如在一个课税年度内是否超过183天或其他相关的最低限期），或如属公司，则根据该公司注册成立地或其中央管理及控制所在地而定[1]。金融机构可要求账户持有人就其税务居民身份提供自我证明，以确定有关账户是否属自动信息交换下须申报的账户。

于2016年9月9日，税务局公布《金融机构指南》（税务局指南），载列相关申报规定及尽职审查程序的进一步详细指引，并载有有关集体投资计划的说明及信托的处理。有关税务局指南的概要载于此文章：crs-legal-update-chinese。

[1]　经合组织已建立一个门户网站，提供有关已承诺实施自动信息交换之司法辖区税务居住地规则的信息： http://www.oecd.org/tax/automatic-exchange/crs-implementation-and-assistance/tax-residency/#d.en.347760

The Common Reporting Standard (CRS) introduced by the Organization of Economic Cooperation and Development (OECD) for inter-governmental automatic exchange of information (AEOI) is a significant initiative that could be a paradigm shift in the financial industry.

CRS will soon be implemented in Hong Kong, following the Inland Revenue (Amendment) (No.3) Ordinance 2016, published in the Gazette and became effective on 30 June 2016. Financial institutions and intermediaries in Hong Kong will be under legal obligation to report to the Inland Revenue Department (IRD) on financial accounts for reportable persons, starting 2017, with first reporting to be made to IRD by 31 May the following year, ie. 31 May 2018. Hong Kong IRD will conduct the first automatic information exchange with relevant jurisdictions on a reciprocal basis by the end of 2018.

According to the IRD: “Under the AEOI standard, a financial institution (FI) is required to identify financial accounts held by tax residents of reportable jurisdictions in accordance with due diligence procedures.  FIs are required to collect the reportable information of these accounts and furnish such information to the Department.  The Department will exchange the information with the tax authorities of the AEOI partner jurisdictions on an annual basis.”

The AEOI requirement will cover individuals who are tax residents of “reportable jurisdictions”, being jurisdictions with which Hong Kong has entered into an AEOI arrangement.  Financial institutions are not required to report information on accounts where the account holder is not tax resident in a jurisdiction with AEOI agreement with Hong Kong.

As stated, in general, whether or not an individual is a tax resident of a jurisdiction is determined by having regard to the person’s physical presence or stay in a place (e.g. whether over 183 days within a tax year) or, in the case of a company, the place of incorporation or where the central management and control of the entity lies.[1] FIs may request account holders to provide self-certifications on tax residency in order to determine whether the accounts fall within scope of reporting under AEOI.

On 9 September 2016, the IRD issued the “Guidance for Financial Institutions” (Guidance), with further detailed guidelines on the relevant reporting requirements and due diligence procedures, and includes clarifications with respect to collective investment schemes, and the treatment of trusts. A summary of the Guidance is set out in this update:

[1] OECD has established a portal which provides information on tax residency rules in jurisdictions which have committed to implementing AEOI: http://www.oecd.org/tax/automatic-exchange/crs-implementation-and-assistance/tax-residency/#d.en.347760

Up until mid-February 2016, foreign institutional investors accessing China onshore bonds through the China Interbank Bond Market (CIBM) would do so via the RQFII/ QFII regime, which is subject to specific restrictions and compliance requirements specifically on investment quota and repatriation.  Access to CIBM was otherwise limited to foreign central banks or monetary authorities, RMB settlement banks and settlement participating banks.

On 24 February 2016, Announcement No. 3 issued by the People’s Bank of China (PBoC) liberalized the CIBM, allowing foreign institutional investors, including commercial banks, insurance companies, fund management companies/asset management institutions, investment products and funds, to directly access the CIBM and trade in onshore RMB bonds upon successful application to their settlement agents.

Subsequently on 27 May 2016 both PBoC and SAFE issued implementing rules setting out the details to put Announcement No.3 into effect. Settlement Agents are delegated with the responsibility to determine the eligibility of foreign institutional investors, which should be ‘medium and long term’ investors.

Both corporate entities and fund/ managed accounts can apply for access. In applying, potential investors will need to fill out information regarding investment period and investment quota, and would also need to indicate whether they are existing RQFII or QFII holders. Existing RQFII or QFII holders will still be subject to the relevant restrictions on capital repatriation and investment quota, whereas a first time CIMB investor will be subject to the specific Announcement No.3 requirements and compliance with a currency ratio on repatriation. It is recommended that investors should enter the CIBM in one capacity only, ie. either through RQFII/QFII or directly under Announcement No.3.

For Hong Kong retail funds authorized by the Securities and Futures Commission (SFC), on 11 July 2016, the SFC issued a FAQ No. 20 under its “Frequently Asked Questions on Post Authorization Compliance Issues of SFC-authorized Unit Trusts and Mutual Funds” (SFC’s FAQ) regarding disclosure and approval requirements for participation in the CIBM. Fund issuers should note the following points reflecting SFC’s disclosure requirements before making such investments.

If a fund shall make a substantial investment in RMB denominated debt/ money market instruments (RMB Bonds) (i.e. 30% or more of the fund’s NAV):

• When the existing investment objectives and strategy do not cover substantial investment in the RMB Bonds, e.g. a US bond fund, prior SFC approval will need to be sought to amend the investment objectives to include RMB Bonds and at least 1 month’s prior notice to investors are required before such investments can be made.
• When the existing disclosures allow investments in RMB Bonds to be made (whether via CIBM or RQFII/QFII regime), generally no further prior approval from SFC is required for accessing the CIBM directly if the fund issuer considers such changes as immaterial (as per definition under SFC’s FAQ).  The fund issuer will still need to notify the shareholders of this change as soon as reasonably practicable.
• The offering documents (including the product key facts statement for Hong Kong investors) should be updated to include further details, e.g. the intended proportion of investments via direct access under Announcement No.3, and additional key risks. While direct access under Announcement No.3 is not subject to quota risks, fund issuers should consider whether other applicable key risks are already set out in the offering documents, e.g. China investment risks including capital control, custody risk. Issuers should also consider inclusion of other specific risks such as uncertainty or lack of clarity on the withholding tax arrangement for investment via CIBM.
• In particular, fund issuers should ensure that proper Mainland custodian arrangements are in place regarding safe custody and segregation of assets for the investment under CIBM, and if the fund is one that primarily invests in the Mainland market (ie. investing more than 70% for Hong Kong funds or more than two-thirds for UCITS funds), the offering documents should include an extract of a Mainland legal opinion (or a confirmation, as applicable) relating to such.
• The updated offering documents should be filed with SFC as soon as practicable.

If a fund shall make an ancillary investment in RMB Bonds (i.e. more than 10% but less than 30% of the fund’s NAV):

• Generally no SFC prior approval is required but fund issuers should ensure that the offering documents should be updated to include further details and risks as outlined above. The updated offering documents should be filed with SFC as soon as practicable and will be subject to post vesting by the SFC.
• The fund issuer should notify the shareholders of this change as soon as reasonably practicable.

If a fund shall make minimal investment in RMB Bonds (ie. less than 10% of the fund’s NAV)

• No SFC prior approval required. Fund issuers should exercise discretion/ judgement and consider if any updates are necessary.

This update is provided for general information only and is not intended as legal advice in any specific case. Please contact Vivien Teu (vivien.teu@vteu.co) or Christina Suen (christina.suen@vteu.co) for any enquiry or assistance on the subject matter.