The Securities and Futures Commission of Hong Kong has decided to require to safeguard clients' assets from sharp practice by forcing firms to sign 'client asset acknowledgement letters' with intermediaries.

The SFC has observed that in some cases the standard terms and conditions that intermediaries agree with authorised institutions (AIs) with respect to current, deposit or securities accounts that are client or trust accounts (collectively, Client Asset Accounts) contain clauses which grant firms a right of set-off or lien. Such clauses, it believes, are fundamentally incompatible with the requisite standard of protection afforded to clients' assets by its Code of Conduct.

To strengthen the safeguarding of client assets, the SFC is to insist on both intermediaries and AIs signing standardised pro forma acknowledgement letters.

The main elements of each acknowledgement letter include some 'notification of purpose' clauses, a 'no-recourse' clause and some 'conflict' clauses. These clauses are in line with long-standing efforts by various countries to protect investors from sharp practice and their analogues exist in other jurisdictions.

The 'no-recourse' clause in the letter template prohibits recourse against clients' assets in Client Asset Accounts. However, in the event of an issuer’s default, the SFC holds that clawback by AIs of prepaid dividends or interest in respect of the issuer’s securities is not to be counted as recourse against clients' assets for the purposes of this requirement. In addition, the no-recourse clause does not apply to any recourse against assets required by a law or a court order.

The letter template further clarifies that in the event of any conflict between the client asset acknowledgement letter and any other agreement between the parties in connection with the Client Asset Accounts, the client asset acknowledgement letter shall prevail.

The client asset acknowledgment letter is applicable to and required for the following types of Client Asset Accounts which are opened with AIs in the names of intermediaries:

• accounts for holding clients' money;
• accounts for holding clients' securities; and
• accounts for holding non-repledged clients’ securities collateral.

Intermediaries are required to have the countersigned letters in place before depositing any clients' money or securities into any new Client Asset Accounts. The transition period for obeying this requirement ends on 31 July 2020, by which time the SFC wants to see the countersigned letters in place for all applicable Client Asset Accounts.