Client onboarding, know-your-client, suitability and client asset protection
Domain 5 tests the front end of the relationship: what a firm must know about a client before advising or dealing, how suitability is evidenced, and how client money and securities are protected.
Know your client
The firm must establish identity, financial situation, investment experience, objectives and risk tolerance, and record the basis of any risk profile. Information must be updated on a trigger event - a change of circumstances, a new product type, or a material market event - not left indefinitely.
Suitability and professional investors
Suitability is assessed against the documented profile; where the product falls outside it, the firm should not recommend it, and if the client insists the transaction is recorded as unsolicited. Professional investors get lighter treatment but not immunity. An individual is a professional investor with a portfolio of at least HK$8 million; a corporation or partnership needs a portfolio or total assets of HK$40 million. Institutional professional investors include banks, insurers, licensed corporations and MPF schemes.
Segregation of client assets
The Client Money Rules require client money to be paid into a trust account with an authorized financial institution, designated as a client account, and not mixed with the firm's money. The Client Securities Rules require client securities to be registered in the client's name or held in a designated client account, or in a segregated CCASS account. Client assets must never finance the firm's own positions or be pledged for the firm's obligations.
Records, statements and audit
Maintain a complete record of client assets, reconcile regularly, issue contract notes and statements of account, and arrange an annual audit of client assets by an independent auditor. The Investor Compensation Fund covers losses from the default of an intermediary in exchange-traded products, up to the statutory cap (HK$500,000 per investor per default).
Worked example
A client with a conservative profile asks for a leveraged derivative. The representative explains the mismatch, documents the discussion, and proceeds only as an unsolicited instruction with the risk disclosure statement signed. Recording the rationale is what protects the firm.
Traps
Treating a signed risk disclosure statement as proof of suitability; assuming professional investors can never complain; using client money for working capital; forgetting that client securities cannot be pledged.