SFC in talks on increased oversight of insurance, dark pool products

Investment-linked policies and the rise of a new trading platform in the spotlight as regulator in talks to increase oversight to protect investors

PUBLISHED : Monday, 25 February, 2013, 12:00am
UPDATED : Monday, 25 February, 2013, 5:00am

The Securities and Futures Commission is in talks with government and regulatory officials over increased oversight of investment-linked insurance products to safeguard the interest of investors.

The regulation was needed in light of the growing popularity of such products in recent years, according to SFC chairman Carlson Tong Ka-shing.

Tong said the SFC will also review the operation of dark pools, an electronic trading platform that may pose a threat to traditional exchanges, to determine whether it needs to impose more regulation to enhance transparency and investor protection.

"We do not yet have any position on the way forward for regulation over investment-linked insurance policies or dark pool operators. We will first conduct an overall review in these two areas and will consult the market if we decide to have any regulatory change," Tong said.

Investment-linked insurance products put a significant portion of their premium returns into investments in a portfolio of equities or investment funds, leaving policyholders to shoulder any gains or losses according to the investment return. This is different from traditional life insurance policies sold by insurers who invest the premium in more conservative products and pay dividends to policyholders.

According to the Office of the Commissioner of Insurance, annualised premiums of investment-linked products sold in the first nine months of last year amounted to HK$7.17 billion, down 19 per cent from the same period in 2011. Sales picked up from the fourth quarter as global stock markets bounced back after governments in September eased monetary policies to keep their economies humming.

Some insurers said up to 40 per cent of policies sold in recent years are investment-linked products.

Tong said the policies are tied to the stock market's performance. They recorded strong sales when the market peaked in 2007 but dropped after the financial crisis broke out in 2008.

"This showed many policyholders bought these products in the hope of getting a return similar to that of investing in the stock market but these products are not subject to the same degree of regulation as investment funds," he said.

Unlike the many retail fund products which are regulated by the SFC - from the approval of the products, their point of sale and ultimately the operation and financial viability of the licensed operator - investment-linked insurance policies only need SFC approval for the documentation of the marketing materials.

Also, unlike mutual funds, the underlying portfolio of investments are not separately held by independent trustees or segregated from the other assets of the insurance companies. As such, if the insurers issuing the products collapse, the policyholders suffer.

Tong said the SFC will work with the government, which has proposed an independent Insurance Authority be set up in 2015, to study how to better regulate these products.

"We want to see that the issuance of the products are properly regulated and to be satisfied that the salesperson explains all the risks involved. The SFC will also study how it and the proposed Insurance Authority can work together" on regulation, he said.

The SFC's other review this year concerns the regulation of so-called dark pools. Dark pools have emerged as a popular platform in recent years in advanced markets such as the United States and Britain. They allow traders to buy or sell large blocks of shares without having to disclose their identities, the volume or prices, as opposed to requirements at traditional exchanges.

These platforms are operated by brokers or independent companies and are popular with pension funds and asset managers as the anonymity allows them to keep their strategies hidden from the public eye, cut transaction costs and avoid setting off unwanted price movements.

Competition between dark pools and traditional exchanges has heated up in the US and Europe, where regulations allow dark pools to run independently of exchanges. In the US, for example, dark pools represent about 50 per cent of all trades.

"The US and many overseas markets are now reviewing their dark pool regulations as their popularity in the West means up to half of all trading is off the main exchange and therefore less transparent than trading in the traditional exchanges," he said.

Dark pools have only a small presence in Hong Kong and many other markets in Asia. The 14 dark pool operators in Hong Kong represent only 3 per cent of total market turnover.

Hong Kong still has stamp duty on each transaction while the law also requires dark pool operators to report trades to HKEx after the transaction.

"We would not like to see Hong Kong falling behind the other markets while developing these new trading pools but at the same time, we want to protect the transparency of our market. The review will try to find a way to achieve a balance between market development and the future regulation of the dark pools," Tong said.