‘Suitability’ clause to be at heart of new contracts in Hong Kong involving financial product sales

Buyers and sellers of financial products should heed new wording in sales contracts

PUBLISHED : Sunday, 20 December, 2015, 3:34pm
UPDATED : Sunday, 20 December, 2015, 3:34pm

The Securities and Futures Commission has unveiled new rules requiring banks as well as other intermediaries that sell financial products to insert a new clause into sales agreements in an effort to help protect consumers.

The 66-word clause however has come under fire from legal experts who say it may open the door to a wave of litigation.

In client contracts, banks must now include the following clause: “If we [the intermediary] solicit the sale of or recommend any financial product to you [the client], the financial product must be reasonably suitable for you having regard to your financial situation, investment experience and investment objectives....No other provision of this agreement or any other document we may ask you to sign and no statement we may ask you to make derogates from this clause.”

The SFC said the clause is intended to bolster accountability and prevent mis-selling of financial products.

“The new clause enables investors to claim for damages under the client agreement, where the recommended product is not reasonably suited,” said Ashley Alder, chief executive of the SFC.

“The changes will result in fairer terms of business for investors, and also prevent intermediaries from misdescribing the actual services provided to the client,” Alder said.

Representatives from the financial industry expressed concerns that the wording of the clause, particularly the operative word “suitable,” could expose them to problems in the future.

If customers later feel the products did not turn out as hoped, they may now have grounds to take banks to court for breach of contract.

Moreover, civil courts are not bound by regulations set under the Hong Kong Monetary Authority and the SFC. The SFC says it may use judgements as precedents and apply them into its own enforcement on a forward basis.

“The SFC obviously has not listened,” said a counsellor at a US law firm commenting on condition of anonymity. “Courts are not there to judge regulatory behaviour. So by introducing a contractual clause, it becomes a matter of contractual breach. It now gives the customer the power to challenge the bank if they think the product is not suitable for them.”

A summary of industry responses on the issue compiled by the SFC over an 18-month period was released last week.

Critics say the SFC has rejected many issues flagged by banks, lawyers and industry stakeholders.

Urszula McCormack, partner at law firm King & Wood Mallesons, who acted on behalf of the Hong Kong Association of Banks in the consultation, said generally, the statutory limit for investors to bring suits would be six years after the event.

“The clause is meant to be applied on a forward-looking basis; although I would not be surprised if some people try to bring retrospective suits. It highlights the need to implement the clause very carefully.”

For global investment banks, outlays to cover lawsuits and settlements between 2008 and 2014 amounted to US$219 billion, according to rating agency Moody’s calculation. These legal costs are rising every year, raising concerns that the system is not sustainable.

Banks in Hong Kong may soon find themselves facing bigger legal bills and the need to set more funds aside to cover higher provisions.