Commissions on investment products and potential conflicts of interest
Most investment advisers (Note 1) in Hong Kong adopt a commission-based business model. That means they do not directly charge the clients any fees for the advisory and product distribution services, but receive commissions (in various forms) from the product issuers for the products sold to clients.
For example, if an investment adviser (e.g. a bank or an advisory firm) sells a fund to a client, it may receive the following commissions (Note 2).
Fund transaction fees (e.g. subscription fee)
For instance, if the subscription fee of the fund is 3% (of your investment amount), then this amount (subject to the distribution agreement) will typically be deducted and kept by the investment adviser, and only the remaining amount (i.e. 97% of your investment amount) will actually be invested in the fund.
Trailer fees (also known as trailer commissions)
A trailer fee is an ongoing commission paid by a fund company to an investment adviser for as long as the client remains invested in the fund. Typically, the fund company will pay part of its annual management fee to the investment adviser. For example, the fund company receives an annual management fee of 2% of the value of the fund it manages and pays 60% of its annual management fee to the investment adviser as a trailer commission.
Potential conflicts of interest
Under a commission-based business model, the income of the investment advisers would depend on a number of factors, including the number of deals they completed, the total amount of assets managed by the fund company for the investment advisers' clients and/or the type of products sold etc. In essence, this remuneration model may provide incentives for the investment advisers to sell products based on how much they can potentially earn. For example, this may incentivise investment advisers to recommend products that come with higher commissions.
Also, investment advisers generally receive upfront subscription fees / switching fees for trade / switching in funds. This may incentivise them to encourage frequent trading / switching of funds which would generate more commissions than clients simply holding their investments in the fund, and which may not be in the clients' best interest. This practice is commonly known as "churning".
To address potential conflicts of interest, on top of the existing disclosure requirements (such as disclosure of subscription fees rebate), investment advisers are required by the SFC to disclose whether or not they are independent (and the reasons for being independent or not independent) and the maximum percentage of trailer commissions (among other monetary benefits) that they will receive from the product issuers (Note 3). Investors are always encouraged to ask their investment advisors or distributors if the investors wish to know more.
Investment adviser is a broad term. In Hong Kong, it generally refers to intermediaries (individuals or companies) selling or advising on different types of investment products.
The front line advisers or relationship managers usually may not receive commissions from the product issuers directly, but their employers (e.g. banks, financial advisory firms) would. These commissions are translated into the sale targets of the front line investment advisers or relationship managers.
These new disclosure requirements come into effect on 17 August 2018.
13 August 2018