SFC Conflict of Interest Management: Separation of Research and Trading Activities in Financial Firms

On 2 January 2025, the Securities and Futures Commission (SFC) issued a circular reminding licensed corporations of their obligations under paragraph 11.1 of the Code of Conduct for Persons Licensed by or Registered with the SFC (the Code). The circular followed a thematic inspection of 15 firms that revealed persistent deficiencies in the management of conflicts between research and trading activities. The SFC found that in 8 of the 15 firms, research analysts were directly involved in pitching deals to issuer clients during equity capital market transactions — a practice that blurs the Chinese wall between objective analysis and sales pressure. This regulatory focus is not new: the SFC published its first “Guidelines on the Management of Conflicts of Interest” in 2015, and the current Code has required segregation since 2003. However, the 2025 circular signals a step change in enforcement. The SFC stated that it will now consider disciplinary action — including fines and licence suspension — against firms that fail to demonstrate effective structural separation. For compliance officers and senior management at licensed corporations, the message is clear: paper policies are no longer sufficient. The SFC expects to see physical separation, separate reporting lines, and documented surveillance of cross-departmental communications.

The Regulatory Framework: SFC Code of Conduct and the “Chinese Wall” Requirement

Paragraph 11.1 and the General Principle of Segregation

The SFC Code of Conduct at paragraph 11.1 provides that a licensed corporation “should ensure that its business activities are conducted in a manner that is fair and equitable to all its clients and that conflicts of interest are avoided.” The Code does not prescribe a single method for achieving this. However, the SFC’s 2015 Guidelines on the Management of Conflicts of Interest set out a hierarchy of controls: avoidance is preferred, followed by disclosure and consent, and finally, management through structural arrangements such as Chinese walls.

The term “Chinese wall” is defined in the SFC’s Code of Conduct Glossary as “an arrangement that restricts the flow of information between different departments of a corporation to prevent conflicts of interest.” For research and trading, the wall must prevent research analysts from having access to non-public information about upcoming trading positions or client orders, and must prevent traders from influencing research output.

The SFC’s 2025 Circular: Specific Expectations

The 2 January 2025 circular identified three specific areas where firms commonly fail. First, physical co-location: in 5 of the 15 inspected firms, research analysts and traders shared the same office floor without physical barriers. The SFC stated that this arrangement “cannot be considered adequate” under paragraph 11.1. Second, reporting lines: in 7 firms, the head of research reported to the head of investment banking or trading. The SFC considers that research should report to a separate business unit or to a compliance function that does not have revenue targets. Third, performance metrics: in 4 firms, research analysts were evaluated on the volume of trades generated by their reports. The SFC stated that such metrics “inherently create a conflict” because they incentivise analysts to produce favourable coverage of clients.

The “Loyalty, Care and Diligence” Standard

The SFC also reminded firms of the common law fiduciary duties that apply to licensed persons. In SFC v. Tiger Asia Management LLC (2013) 16 HKCFAR 324, the Court of Final Appeal confirmed that the SFC can bring proceedings for breaches of the Code of Conduct as “market misconduct” under Part XIII of the Securities and Futures Ordinance (Cap. 571). While Tiger Asia dealt with insider dealing, the principle extends to conflicts of interest: a failure to manage conflicts can amount to a breach of the duty of loyalty owed to clients. The SFC’s 2025 circular explicitly references this duty, stating that “the obligation to manage conflicts is not merely a regulatory requirement but a fiduciary one.”

Practical Steps for Separation: Structural, Operational, and Supervisory Controls

Step 1: Physical and IT Segregation

The SFC expects licensed corporations to implement physical separation between research and trading departments. This does not necessarily require separate buildings, but it does require separate floors or clearly demarcated zones with access controls. The SFC’s 2015 Guidelines state that “firms should consider the use of locked doors, swipe card access, and separate print servers.”

On the IT side, the SFC expects separate file servers, separate email systems, and restricted access to trading systems for research staff. The SFC’s 2025 circular noted that in 3 of the 15 inspected firms, research analysts had direct access to the firm’s order management system. The SFC stated that this “creates a risk that analysts could see client order flow and adjust their recommendations accordingly.” The solution is role-based access control (RBAC) with audit trails. Each user should have access only to the systems necessary for their role, and all access should be logged and reviewed monthly.

Step 2: Separate Reporting Lines and Compensation Structures

The SFC’s 2025 circular is explicit: the head of research must not report to the head of investment banking or trading. The preferred structure is for research to report to a separate “Research Oversight Committee” that includes the chief compliance officer and a non-executive director. If the firm is too small for this structure, research should report directly to the chief executive officer or to the compliance function.

Compensation is equally important. The SFC stated that “research analysts should not be compensated based on the profitability of the trading desk or the investment banking division.” The SFC’s 2015 Guidelines recommend that research analyst compensation be based on the accuracy of their forecasts, the quality of their analysis, and client satisfaction surveys — not on revenue generation. In practice, this means that bonus pools for research staff should be separate from bonus pools for trading and investment banking staff.

Step 3: Surveillance and Record-Keeping

The SFC expects firms to have documented surveillance procedures for cross-departmental communications. This includes monitoring of emails, instant messages, and phone calls between research and trading staff. The SFC’s 2025 circular stated that firms should “conduct periodic reviews of communications to identify any instances where trading staff have requested changes to research reports.”

Record-keeping requirements are set out in the Securities and Futures (Records) Rules (Cap. 571P). Rule 3 requires that all records relating to the conduct of regulated activities be kept for at least 7 years. For conflict-of-interest management, this includes records of: Chinese wall access logs, surveillance reports, compliance committee minutes, and any disclosures made to clients.

Enforcement Trends and Penalties

Recent SFC Disciplinary Actions

The SFC has not been reluctant to impose significant penalties for conflict-of-interest failures. In 2023, the SFC fined a global investment bank HK$10 million for failing to maintain adequate Chinese walls between its research and proprietary trading desks. The SFC’s press release stated that the bank had “permitted research analysts to attend trading desk meetings and to receive information about the firm’s trading positions.”

In 2024, the SFC reprimanded and fined a mid-cap brokerage HK$4.5 million for a similar failure, noting that the firm’s compliance manual had adequate policies but that these policies were “not implemented in practice.” The SFC stated that “the absence of documented surveillance and the lack of separate reporting lines constituted a systemic failure.”

The SFC’s Enforcement Approach Under the 2025 Circular

The 2025 circular signals that the SFC will now take a more aggressive enforcement posture. The circular states that the SFC “will consider disciplinary action against licensed corporations and their senior management where there is evidence of a failure to implement effective conflict-of-interest controls.” This includes potential licence suspension or revocation under section 194 of the Securities and Futures Ordinance (Cap. 571).

For senior management, the SFC can also take action under the “fit and proper” test in section 129 of the Ordinance. A director or responsible officer who is found to have failed to supervise conflict-of-interest controls may be found not fit and proper, leading to a ban from the industry. The SFC’s 2025 circular explicitly warns that “the conduct of senior management will be scrutinised in any enforcement action.”

The Role of Internal Audit and External Compliance Reviews

The SFC expects firms to conduct annual internal audits of their conflict-of-interest controls. The 2025 circular recommends that firms engage external compliance consultants to perform a “health check” at least once every two years. The external review should cover: the adequacy of Chinese walls, the effectiveness of surveillance procedures, and the independence of the research function.

Industry Best Practices: What Leading Firms Are Doing

Goldman Sachs: The “Research Integrity” Model

Goldman Sachs’ Hong Kong operations have been cited by the SFC as a benchmark for research independence. The firm maintains a separate “Research Integrity” team that reports directly to the chief compliance officer. This team reviews all research reports before publication to ensure that no trading desk input has influenced the content. The firm also uses a “restricted list” system: when the trading desk takes a significant position in a stock, that stock is placed on a restricted list, and research analysts are prohibited from publishing any new reports on it until the position is closed.

Morgan Stanley: Physical Separation and “Clean Teams”

Morgan Stanley’s Hong Kong office uses a “clean team” model for equity capital market transactions. When a research analyst is required to participate in a deal team (for example, to provide industry expertise for an IPO), the analyst is physically separated from the rest of the research department and is subject to a “clean team” protocol that restricts their access to non-public information. The clean team arrangement is documented in a written agreement that specifies the scope of the analyst’s work and the duration of the arrangement.

Small Firms: The “Compliance-Outsourced” Model

For smaller licensed corporations that cannot afford dedicated compliance staff, the SFC’s 2025 circular acknowledges that outsourcing is acceptable. The SFC’s “Guidelines on Outsourcing” (2019) permit licensed corporations to outsource compliance functions to external service providers, provided that the firm retains ultimate responsibility. In practice, small firms can engage an external compliance consultant to conduct quarterly reviews of Chinese wall controls and to prepare surveillance reports. The firm must still maintain its own records and must ensure that the external consultant has access to all relevant systems.

Key Takeaways

• The SFC’s 2 January 2025 circular makes clear that physical separation, separate reporting lines, and documented surveillance are now mandatory expectations, not optional best practices.
• Licensed corporations must review their compensation structures for research analysts to ensure that bonuses are not linked to trading or investment banking revenue.
• Senior management faces personal liability under the “fit and proper” test if they fail to supervise conflict-of-interest controls.
• Small firms may outsource compliance monitoring to external consultants, but the firm retains full regulatory responsibility for any failures.
• Internal audits and external compliance reviews should be conducted annually and biennially, respectively, with results reported to the board of directors.

This does not constitute legal advice. Consult a solicitor for your specific case.