While some industry participants say Hong Kong’s first guidelines for online fund distribution provide clarity that may drive more investors to digital platforms, others believe further steps must be taken to spur growth.
Hong Kong’s Securities and Futures Commission launched a consultation in May last year seeking feedback on draft guidelines to address potential risk from online distribution and advisory platforms, or robo advisors. Conclusions of the consultation were issued at the end of March.
The guidelines provide some direction on what circumstances create a requirement for an assessment of investor suitability for the online sale of investment products. For example, the posting of factual, fair and balanced, product-specific materials, such as lists of investment products, model portfolios, and adverts of fee discounts, in itself would not trigger the suitability requirement.
Robo-advisory platforms that include automatic portfolio rebalancing – as well as those that offer product-specific incentives or employ taglines such as “Don’t Miss Out!” or “Act Now!” – do trigger the requirement. The guidelines will come into effect beginning April next year.
“Archaic” signatory requirements
“In the consultation, nothing came as any surprise to us,” says Mikaal Abdulla, Tokyo-based CEO at 8 Securities, which launched Hong Kong’s first robo-advisor platform in 2015 and now runs a mobile-based automated investing app called “Chloe” in Japan and Hong Kong.
“It actually doesn’t change anything with our onboarding process, and we are not intending to make any further changes to that,” says Abdulla.
Like most other robo-advisory platforms, 8 Securities’ Chloe already runs suitability assessments on investors in order to place them in one of three model risk portfolios of locally listed exchange-traded funds.
Abdulla says that the initial, simple portfolio-matching and suitability process has never been a challenge but, rather, it is the account opening procedures that are burdensome.
Particularly, the persistence of the SFC to require a physical, or “wet”, signature from the client rather than a digital signature is “archaic” and still ultimately means that most customers have to physically sign off on verifying an online account, he adds.
“You can imagine how frustrated customers are by going through that process,” says Abdulla. “It starts off quick, simple and easy, but then at the end, they have to physically visit an office in person.”
In Japan, where a digital signature can be used and online investing is fully digitised, 90% of customers who download 8 Securities’ Chloe robo app complete the application process, fund their accounts and become active customers. In Hong Kong, the conversion rate is only 60%.
The only material difference between the process in the two markets is the digital signature, says Abdulla, and if Hong Kong were to introduce this, then conversion rates would increase by 30% to 40%, he estimates.
The Chloe app, which was launched in November 2016, has seen its assets double between the first quarter of 2017 and the first quarter this year. The platform’s average customer age is 29, and the average portfolio size is about US$800.
Drawing the positives: transparency, ETFs
While the SFC’s final consultation conclusions might not lead to substantial changes for existing players in Hong Kong’s nascent robo-advisor industry, some early participants drew positives from the fact that the SFC has created clearer, regulated guidelines for new entrants to the enter the space, which will ultimately benefit end-investors.
“It’s certainly a step in the right direction,” says Alex Ypsilanti, Hong Kong-based CEO at Quantifeed, a provider of robo-advisor software to financial institutions in the region. The company was established in 2013 and now has 30 employees and three clients in Hong Kong as well as seven clients in other markets, including China, Singapore, Australia and Taiwan.
“It’s very encouraging to see that there is a willingness from the regulator to enter into a dialogue of sorts, and they are obviously taking robo advice quite seriously,” he adds.
The SFC’s regulatory framework also clarified that a portfolio-based risk assessment may be used for checking suitability. This approach can provide investors with better asset allocation in terms of risk and return, says Li Ting, Hong Kong-based CEO at Yunfeng Financial Group.
Twelve months ago, Yunfeng Financial launched Youyu Robo, a mobile app that uses mutual funds to construct portfolios. The platform builds online portfolios for investors with more than 350 funds offered by 18 different fund houses.
For instance, emerging market equities funds may be considered a high-risk asset class individually, but from an overall asset allocation perspective, a 5% allocation to the asset class may boost expected returns and lower expected risks due to low or even negative correlation with other asset classes, Li explains.
“We also support the SFC’s clarification on the level of suitability required, depending on whether the online platform would provide any advice concerning specific investment products,” adds Li.
One section of the conclusions that could be of significant benefit to the development of robo platforms in Hong Kong is that shares or physical ETFs traded on a U.S. exchange would be considered as non-complex and therefore could be sold online to investors without the requirement of additional assessments, risk disclosures or even restrictions.
“In its inception, robo advice is very much about giving the end-investor a choice around liquidity, transparency and low fees, and ETFs are central to many robo solutions,” says Ypsilanti.
The breadth and depth of asset classes and liquidity in Hong Kong’s domestic ETF market is fairly limited and not comparable to the U.S., so not allowing the use of U.S.-listed ETF products for robo-advisory platforms was a bit of a gap, he adds.
For the moment, however, 8 Securities believes that portfolios of local ETFs are better for attracting online investors in the territory.
Clients tend to prefer Hong Kong dollar portfolios because they are younger, and there are many prominent managers such as Vanguard and BlackRock with numerous Hong Kong-listed ETFs, says 8 Securities’ Abdulla.
Prospects for future growth
Despite notable growth of online robo platforms in some other markets, the number of robo advisors in Hong Kong can still be counted on just one hand.
While the SFC has now made its initial move in laying a clearer framework for the robo-advisor industry in Hong Kong, opinions are mixed on how quickly the industry will grow and the extent to which these regulations will encourage growth.
“We expect an increase in the players in this space, most likely from existing traditional financial institutions who already have offline fund distribution,” says Yunfeng FG’s Li.
Since building an entire online distribution division from scratch will be costly and time consuming, partnering with established online players can help institutions ensure low upfront costs and a quicker time to market, she adds.
In theory, the changes could help the robo industry grow, but given demands for the regulatory capital to cover all aspects of compliance, start-ups probably need to raise up to US$5 million to launch a platform, says 8 Securities’ Abdulla.
In addition, banks in Hong Kong don’t seem to be particularly motivated to launch robo advisors, as it would just cannibalise their existing in-branch sales business for which they can charge 5% or 6% in upfront commissions, he adds.
“From that perspective, I worry, because I don’t see too many robo advisor start-ups launching in Hong Kong or even close to launching in Hong Kong, and until they do, I don’t see the banks necessarily changing either,” says Abdulla.
The potential cannibalisation of the existing high-margin business is certainly something that most financial institutions in the region that are considering robo platforms grapple with, says Quantifeed’s Ypsilanti.
But instead of the start-up robo platforms, it’s the threat of big tech companies, such as Tencent, Alibaba or Google, that are muscling into the online wealth management space that is pushing banks to make a move sooner rather than later.
Ypsilanti cites a recent example of winning a contract where the view of the institution was: “If we don’t do it, then we know somebody else will. So even if it means disrupting our existing businesses, we need to move now and stay ahead of the game.”
Indeed, the launch of new robo-advisory platforms by major financial institutions in Hong Kong that are aimed at retail investors may be just around the corner.
“Perhaps in the next few months, but certainly by year-end, there will be a couple of big financial institutions launching robo advisors,” says Ypsilanti.