Chris Hamblin examines the rules that surround this peculiar class of client in the financial hubs of Dubai, Singapore and Hong Kong and concludes that, far from being an excuse for corner-cutting, the entire subject is a troublesome minefield.

In this article Chris Hamblin, editor of Compliance Matters and Offshore Red, sister publications to WealthBriefingAsia, examines the rules that surround this peculiar class of client in the financial hubs of Dubai, Singapore and Hong Kong and concludes that, far from being an excuse for corner-cutting, the entire subject is a troublesome minefield.

THE PROFESSIONAL CLIENTS OF DUBAI

Dubai’s relevant provisions are to be found in the conduct-of-business or COB module of the DFSA’s rulebook. COB 2.2, guideline 4, states that any authorised firm can choose to deal with a professional customer as though he is merely a retail customer if it so desires. A client is always a retail client to the extent that he is not a professional client (2.3.5). COB 3.2.4(1)(c) states that if any marketing material is intended only for professional clients, it has to bear a clear statement to that effect which says that nobody else should act upon it.

COB 3.2.5 obliges every authorised firm to take reasonable steps to ensure that marketing material for professional clients does not go to anyone else – the onus for this might fall on the relevant relationship manager.

SUITABILITY OF ADVICE

When it comes to suitability assessments, COB 3.4.2(2) allows a firm to limit the extent to which it considers suitability when making a recommendation to, or transacting on a discretionary basis for, a professional client as long as it has done two or three things beforehand.

• Warned the client in writing that it will not consider suitability, or at any rate only to a certain extent in accordance with what it has outlined in the notice.
• Obtained express consent from the client by persuading him to sign the notice.
• Kept an eye on whether any discretionary portfolio management account it runs for the client is appropriate for him.

The accompanying ‘guidance’ suggests – as it does throughout COB – that the firm might want to limit the client’s ‘professional’ status to only a few of his objectives or to a limited product range. COB, indeed, is riven with rules designed to make it easy for the private bank or asset management firm to declassify someone as a professional client.

As one would expect, COB 3.5.6 draws no distinction between ordinary and professional clients when obliging firms to disclose any potentially hidden ‘soft-dollar’ elements to their charges.

COB 6.9.2(1) states that when an authorised firm transacts for a client it must send that client a confirmation note as soon as possible and in any case no later than two business days upon execution of the transaction. This, however, is waived for professional clients as long as they have asked for waivers in writing, according to note (4).

On the subject of what the DFSA calls ‘core information’, i.e. the information that the RM or his or her firm must give the client no matter what, COB A2.1.2 contains chapter and verse. It dictates that retail clients must receive data about:

• (a) the firm’s name, address, whether it is a subsidiary or not, and the name and address of its ultimate holding company;
• (b) its regulatory status;
• (c) when and how the client agreement is to come into force and how to end it;
• (d) the services it is to provide, along with information about restrictions or a declaration that there are none;
• (e) fees, costs and other charges and what engenders them;
• (f) any conflicts of interests (dealt with in rule 3.5.1);
• (g) any soft-dollar agreement that should come to light under rules 3.5.6 and 3.5.7; and
• (h) complaint-handling procedures.

Professional clients, however, need not receive (d), (e), (f), (g) and (h).

Appendix 5 contains the DFSA’s client money provisions, which govern conduct for firms that handle such monies and oblige each one to send each customer a statement of total client money balances held, the amount, date and value of each credit and debit and any interest earned or charged. A5.10.1(1) obliges a firm to send a statement to a retail client at least once a month but it can do so at other agreed intervals with a professional client. The same kind of arrangement applies under A6.8.1 for firms that provide custodial services – here the statement must be every six months except at the express written order of the professional client.

THE CLASSIFICATION STAGE

What, then, qualifies someone to be a ‘professional client’ in Dubai? COB 2.3.2(1) states that it can only happen if:

• (a) the client has net assets, held directly or indirectly, of at least $500,000 (excluding the value of his primary residence), or if he is, or has been in the previous two years, an employee of an authorised firm; and
• (b) reasonably appears to the firm to have ‘sufficient experience’ of financial markets, products, transactions and risks; and
• (c ) has not elected to be a retail client.

COB 2.3.2(2) goes on to list a great many things that might be tantamount to the ‘sufficient experience’ of (b), but these only apply to corporations that might also be ‘professional clients’. It is likely that most of Dubai’s so-called professional clients are not natural persons at all, although the jurisdiction has no shortage of wealthy operators and traders in financial markets.

THE EXPERT INVESTORS OF SINGAPORE

The Singapore Financial Advisers Regulations regulate financial advisers and their representatives. Section 25 dictates that every licensed financial adviser should keep books in English. It says that for the purposes of s45(2) Financial Advisers Act 2001 [which states that a licensed financial adviser shall (a) keep books to explain his/its transactions and financial position in Singapore and allow true and fair profit-and-loss accounts and balance-sheets to be prepared from time to time; and (b) keep them so they can be audited properly] a licensed financial adviser must keep books which contain the following:

• (a) the particulars of every one of his/its clients;
• (b) details of all transactions he/it has carried out for his/its clients;
• (c and d) a copy of every written agreement he/it has struck with any of his/its clients;
• (e) a copy of every written agreement he/it has struck with any product provider;
• (f) everything he/it has distributed to existing or prospective clients;
• (g) all his/its income and expenses; and
• (h) all his/its assets and liabilities and information about whether they are held as security against any loan(s).

The Financial Advisers’ Regulations, however, exempt the financial advisor and his/its representatives – such as relationship managers – from s25 if he/it is advising an accredited or expert investor. Section 33 states explicitly that it will not apply to an advisory service in respect of any designated investment product that is a capital markets product, to an expert investor. Section 33(2) obliges the advisor to tell the expert investor about the exemption unless that expert investor is also a corporation (which is possible) or someone “connected to the licensed financial adviser.” There are criminal penalties for breaking s33(2), so it is imperative to get it right.

What, then, is an expert investor? Section 2 of the Financial Advisers Regulations states that s4A(1)(b) Securities and Futures Act has the answer. This defines such a person as someone whose business involves the acquisition and disposal, or the holding, of capital markets products, whether as principal or agent; the trustee of such trust as the Monetary Authority of Singapore may prescribe, when acting in that capacity; or someone else whom that authority may prescribe. In this Act, ‘prescribe’ means ‘describe’, as proven elsewhere in s2, when the Act talks about the authority ‘prescribing’ things as capital markets products. In Singapore, therefore, one can be appointed as an expert investor and not just revealed to be one.

ACCREDITATION AND ITS BENEFITS

A Singaporean expert investor is not to be confused with an accredited investor, which seems to be a type of ‘sophisticated investor’ as seen in the United States but not in the United Kingdom. Such a person enjoys many of the same immunities as the ‘expert’ but relies solely for his status on his net personal assets exceeding $2 million (or its equivalent in a foreign currency) in value or his income in the preceding 12 months not dropping below $300,000. Once again, the MAS has the power to bestow ‘accredited’ status on someone if it pleases (s4A(1)(a) SFA).

THE PROFESSIONAL INVESTORS OF HONG KONG

In Hong Kong these ‘experts’ are called ‘professional investors’.There are many requirements that the relationship manager (or the compliance department for which he collects information) can waive when he or she encounters one, according to the Code of Conduct for Persons Licensed or Registered with the Securities and Futures Commission. One of the broadest of these is the requirement (waived at paragraph 5.1A) to assess the customer’s knowledge of derivatives and ‘characterise’ him accordingly as part of standard know-yourclient or KYC procedures.

If the relationship manager has the task of distributing an investment product to a customer, he or she normally has to supply him with information before or at the point of sale about whether his or her firm is acting as principal or agent; what its affiliation is with the product provider (known in Hong Kong as a product issuer); all benefits, whether monetary or not; and the relevant terms and conditions (para 8.3A). None of this applies if the relationship is with a professional investor.

Other provisions that the professional investor’s relationship managers can waive are found in para 15.5. These are:

• the need to establish his financial situation, investment experience and investment objectives;
• the need to establish the suitability of a recommendation or solicitation;
• the need to send him risk disclosure statements;
• the need “to obtain from the client an authority in a written form prior to effecting transactions for the client without his specific authority” – a seemingly tautological phrase that seems (according to para 7.1(a)(ii)) to describe a ‘blanket’ authorisation to conduct business on the high-net-worth customer’s behalf without moment-to-moment consent;
• the need to confirm that authority every year;
• the need to inform him about the bank/asset management firm and the identities and status of its employees and others acting on its behalf;
• the need to confirm the essential qualities of a transaction with the client promptly after effecting it; and
• the need to provide the client with documents (in Chinese or English) regarding the Nasdaq-Amex Pilot Programme which, despite its temporary-sounding name, has been going strong on the Hong Kong stock market since 2000, allowing US-listed companies to be listed there also.

‘Professional investors’ can (as in other jurisdictions) be firms and insurance houses, that is to say corporations, but what does the SFC mean when it applies the term ‘professional investor’ to a human client? Schedule 1 of the Securities and Futures Ordinance, according to para 15.2 of the code, delineates two broad categories – A and B. A contains any intermediary or provider of investment services who is regulated anywhere abroad; any authorised insurer from anywhere in the world; any approved trustee or service provider as defined in section 2(1) of the Ordinance or anyone who acts as an investment manager for any such registered scheme or constituent fund. B is any person of a class which is prescribed by rules that the SFC has made according to the powers granted it by s397 of the Ordinance.

TOO MUCH TROUBLE?

In Eastern UK-influenced jurisdictions and elsewhere, one of the common features of the regulatory rules that surround ‘market professionals’ who are also high-net-worth investors is their complexity. It is absolutely vital for the bank in question to get the classification process right and private banks and asset management firms often get it wrong. It is also important to note that good regulatory compliance is no bar to the bank in question being sued for negligence for giving the high-net-worth client sub-standard advice. Yet another complicating factor is the fact that rich individuals the world over are notoriously reluctant to receive waivers through the post and send replies back in the right manner and in the right time-frame. The same goes for the various reports they have to handle. Private banks and fund firms might conclude that the classification of a customer as a ‘professional client/investor’ or an ‘expert investor,’ however prestigious it may sound, is more trouble than it is worth.