5 November 2009 SFC Consults on Structured Products Marketing Regime Introduction As part of the ongoing reforms anticipated in the Consultation Paper on Proposals to Enhance Protection for the Investing Public published in September, the Securities and Futures Commission (the SFC ) has on 30 October published 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 setting out its proposed plans for overhaul of the regulatory regime for unlisted structured products in Hong Kong. Instead of the existing bifurcated approach of regulating public offers of structured products in the form of debentures under the prospectus regime of the Companies Ordinance (the CO ) and public offers of non-debenture structured products under the investment offers regime detailed in Part IV of the Securities and Futures Ordinance (the SFO ), the proposal is to create a single level playing field for all unlisted structured products (whether in the form of debentures or otherwise) through SFO regulation. The proposal is to create a single level playing field for all unlisted structured products (whether in the form of debentures or otherwise) through SFO regulation. Key Proposal - Regulation of Unlisted Structured Products under the SFO The key proposal is to introduce the new concept of structured products (see proposed definition at the end of this bulletin), to remove structured products in the form of debentures (such as equity-linked notes and credit-linked notes, which have proven popular in the past with the Hong Kong investors) from the CO prospectus regime and to bring them under the SFO regime, which currently also regulates structured products not in the form of debentures. The CO prospectus regime would also continue to apply to public offers of plain vanilla debentures i.e., debt capital raisings not in the form of structured products. As regards regulation of listed structured products, The Stock Exchange of Hong Kong Limited will remain the primary regulator. 1
These proposed changes are significant in several respects: > Retail Structured Products to be Authorised by the SFC It is proposed that documents containing an invitation to the public to acquire unlisted structured products (whether or not in the form of debentures) would need to be authorised by the SFC under Part IV of the SFO. This proposal is supplemented by the new Code on Unlisted Structured Products proposed to be published by the SFC which will contain certain criteria, including certain eligibility requirements and disclosure benchmarks for unlisted structured products, which the SFC would normally consider before exercising its power to authorise the issue of offering documents or advertisements for unlisted structured products. > Differences in Liability Regime for Offering Documents and Marketing Materials The CO prospectus regime differs from the offers of investments regime in Part IV of the SFO in some respects including, for example, the liability regime for offering documents and marketing materials. Proposed regulation under the SFO regime would mean that prospectus liability under the CO will no longer apply to offer documents and marketing materials relating to structured products in the form of debentures. Instead, the criminal and civil liabilities imposed under the SFO would be applicable. These include liabilities imposed under sections 107 and 108 of the SFO for misrepresentation which, unlike the CO, apply not only to public offers but also private placements of investment products. The CO prospectus regime also requires prospectus registration at the Companies Registry and experts consents for inclusion of experts reports in the prospectus, neither of which is required under the SFO regime. > Minimum HK$500,000 Denomination and No More than 50 Person Safe Harbours no longer available for Structured Product Offerings By removing the regulation of structured products in the form of debentures from the CO to the SFO, the proposed changes would mean that the safe harbours in the Seventeenth Schedule to the CO, including the "minimum HK$500,000 denomination" and "no more than 50 persons" exemptions which are commonly used in connection with offers of structured products in the form of debentures in Hong Kong, will no longer be available for such offers. There are no equivalent exemptions in the SFO to the CO minimum HK$500,000 denomination exemption and the no more than 50 persons exemption. Exemptions under Part IV of the SFO, such as the offers to professional investors exemption, will remain available and private placements (i.e., offers that are not made to the public) will not be subject to the section 103 restriction. As the bright line exemptions would no longer be available, these proposals would mean that issuers and managers would need to tread more carefully in conducting any private placement to nonprofessional investors of unlisted structured products which are not SFC authorised. > Wide Definition of Structured Products Although certain types of structured products and derivatives are already regulated under the SFO regime, the proposed definition of structured products widens the universe of structured products and derivatives subject 2 SFC enhances protection for Hong Kong investors 05 November 2009
to SFO regulation since the definition clearly covers various types of cash and physically settled structured products and over-the-counter derivatives referencing a broad range of underliers. The breadth of the proposed definition of structured products means that convertible bonds, exchangeable bonds and subscription warrants may be caught under the SFO regime. The SFC has indicated that in reviewing traditional convertible bonds, it will draw reference from the disclosure requirements in the Third Schedule to the CO which currently applies to these products. Since this wide proposed definition would also catches plain vanilla floating rate notes, floating rate notes are proposed to be carved out from the definition of structured products and will fall under the CO regime. Floating rate notes means debt securities under which the holder is paid interest at pre-determined intervals at a rate equal to a money market reference rate that is widely quoted and a fixed amount. As currently proposed, the boundaries of the CO and SFO regime need to be more clearly delineated. For example, it is unclear whether a simple floating rate repackaging note (which is issued by a special purpose vehicle where recourse is limited to the collateral and therefore the investor is exposed both to the credit of the swap counterparty and the quality of the collateral) would fall under the CO or the SFO regime. In addition, the retention of the existing definition of regulated investment agreement (which is defined so that the referenced underlier is property ) means that the types of over-the-counter derivatives subject to SFO regulation may be more limited than that of structured products (as the referenced underliers for such instruments may, in addition to property, be securities, commodities, indices, interest rates, currency exchange rates, futures contracts as well as the occurrence or nonoccurrence of events). > Expanded Definition of Securities The definition of securities under the SFO is proposed to be expanded to cover structured products. This would subject the expanded spectrum of structured products and derivatives to the SFO provisions that apply to securities. > Currency Linked Instruments and Money Market Instruments Issued by Banks are Excluded It is proposed that the section 103 offer restrictions would not apply to documents in respect of the issue of a currency linked instrument or a money market instrument by an authorised financial institution. The SFC s intention is to ensure that the common types of currency linked and interest rate linked products issued by banks will not be caught under the prohibition in section 103(1) of the SFO. 3 SFC enhances protection for Hong Kong investors 05 November 2009
Other Proposals The Consultation Paper also outlines other proposals including the following: > Exemptions for Offers through Licensed Intermediaries not available for Unlisted Structured Product Offerings The SFC proposes to exclude unlisted structured products from the exemptions set out under section 103(2)(a) and section 103(5)(a) of the SFO which allow offer documents and marketing materials to be distributed through Type 1, Type 4 or Type 6 licensed intermediaries without SFC authorisation. As a result, the issue of offer documents and marketing materials relating to unlisted structured products would require prior SFC authorisation, unless it falls within another exemption under the SFO such as the professional investors exemption. Contacts For more information please contact any of the following people or your usual Linklaters contact: Andrew Malcolm Tel +852 2842 4803 andrew.malcolm@linklaters.com Chin-Chong Liew Tel +852 2842 4857 chin-chong.liew@linklaters.com Under the proposals, issuers of listed structured products can generally continue to use the exemption in section 103(2)(a) of the SFO for Type 1, Type 4 and Type 6 licensed intermediaries to issue marketing materials via their related licensed entities without having to seek SFC s prior authorisation. These licensed intermediaries must, however, abide by the Guidelines on marketing materials for listed structured products published by the SFC and must satisfy the relevant Listing Rules requirements. > Compliance with Non-prospectus Related Provisions Applicable to Debentures under the CO Since structured products in the form of debentures would still be debentures under section 2 of the CO, Hong Kong companies would still need to comply with the non-prospectus related provisions applicable to debentures in the CO. These include sections 74A to 79 covering such topics as maintenance of the register of debenture holders, meetings of debenture holders and liability of trustees for debenture holders. Karen Yung Tel +852 2901 5230 karen.yung@linklaters.com I-Ping Soong Tel +852 2901 5181 i-ping.soong@linklaters.com Carl Fernandes Tel +852 2842 4186 carl.fernandes@linklaters.com Umesh Kumar Tel +852 2842 4894 umesh.kumar@linklaters.com > Definition of Debentures to be Clarified There is currently some uncertainty as to whether or not other securities in the definition of debenture in the CO includes securities which are not debt securities. The proposed amendment to the definition of debenture in the CO clarifies that the reference to other securities is to other debt securities. Conclusion The SFC invites comments on these proposals which are due on 31 December 2009. If adopted, these proposals represent a fundamental change to the marketing of structured notes in Hong Kong. 4
Proposed Definition of Structured Product It has been proposed that Structured Product be defined to mean any- (a) instrument under which either or both of- (i) some or all of the returns or any other amounts due, or both, are payable or purport to be payable; and (ii) the method of settlement, whether by payment of cash or by delivery of any type of securities, commodity, property, futures contract or otherwise, is determined or purports to be determined; by reference to one or more of the following: (A) changes in the value or level (as the case may be) of any type of securities, commodity, index, property, interest rate, currency exchange rate or futures contract; (B) changes in the value or level (as the case may be) of a basket of more than one type of securities, commodities, indices, properties, interest rates, currency exchange rates or futures contracts; or (C) the occurrence or non-occurrence of an event or events specified in the instrument; (b) regulated investment agreement; or (c) interests, rights or property which is interests, rights or property, or is of a class or description of interests, rights or property, prescribed by notice under section 392 of this Ordinance as being regarded as a structured product in accordance with the terms of the notice, whether or not falling within subparagraphs (i) to (iv) below, but does not include- (i) a direct interest in any collective investment scheme; (ii) depositary receipts; (iii) preference shares; (iv) a floating rate note; and (v) interests, rights or property which is interests, rights or property, or is of a class or description of interests, rights or property, prescribed by notice under section 392 of this Ordinance as not being regarded as a structured product in accordance with the terms of the notice. This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters LLP. All Rights reserved 2009 Linklaters LLP (www.linklaters.com) is a limited liability partnership registered in England and Wales with registered number OC326345. It is a law firm regulated by the Solicitors Regulation Authority (www.sra.org.uk). The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of Linklaters LLP members together with a list of those nonmembers who are designated as partners and their professional qualifications may be inspected at our registered office, One Silk Street, London EC2Y 8HQ and such persons are either solicitors, registered foreign lawyers or European lawyers. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by emailing us at marketing.database@linklaters.com. 5