HONG KONG: SFC Concludes Consultation on Asset Management Regulation

Thursday November 16 2017

On 23 November 2016, the Securities and Futures Commission (SFC) issued a Consultation Paper (Consultation Paper) on Proposals to Enhance Asset Management Regulation and Point-of-sale Transparency inviting public comments on proposed amendments to (a) the Fund Manager Code of Conduct (FMCC) and (b) the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Code of Conduct) (collectively, the Proposals). These Proposals were made with a view to enhancing asset management regulation in light of international regulatory developments and point-of-sale transparency to better address potential conflicts of interest in the sale of investment products.

The SFC has made clear in the introductory paragraph of Appendix 1 to the FMCC that discretionary account managers should observe the principles and requirements applicable to fund managers more generally to the extent relevant to the functions and powers of the discretionary account manager.

Regarding liquidity management, the SFC acknowledges that discretionary account managers typically either establish a bespoke investment mandate with their clients or manage the accounts based on a pre-defined model investment portfolio selected by their clients. However, this should not affect the need for discretionary account managers to integrate liquidity management in investment decisions or to regularly assess the liquidity of the assets held in discretionary client accounts. Moreover, it is important that other liquidity management principles should apply subject to the capital withdrawal policy agreed with the client.

Once the fund has been set up, the fund manager’s role will focus mainly on day-to-day operations and investment management. For major issues such as pricing errors and fair valuations, the fund manager would likely need to make recommendations or proposals to the board on how such issues should be dealt with. The board, as the governing body, can decide against a recommendation of the fund manager and has final decision-making power.

For funds adopting a unit trust structure, the fund manager would typically need to seek the agreement of the trustee on important matters.

Where a fund manager is only appointed as a sub-advisor or a sub-manager, the fund manager will likely only be involved in day-to-day management of the portion of the fund that has been delegated to it.

De facto control

The SFC recognizes the role that the governing body of a fund plays in the operation of a fund. However, given the important role played by a fund manager in the day-to-day investment management of fund assets and the duties it owes to the fund and fund investors, we expect that fund managers should use due skill, care and diligence to comply with the requirements in the FMCC to the extent this is within the fund manager’s control.

By introducing the concept of “de facto control”, we do not disregard the function of a fund’s governing body. However, although a fund manager may not be formally responsible for making decisions, it may still in substance be responsible for the overall operation of a fund, and therefore should be subject to the relevant requirements in the FMCC. A fact-based review should identify who, in substance, is responsible for the overall operation of the fund.

The SFC have no intention to give any legal effect to the “de facto control” concept. Therefore, references to “having de facto control of the oversight or operation of a fund” will be removed from the final revisions to the FMCC. Accordingly, the relevant proposed enhancements to the FMCC would be applicable only to fund managers that are “responsible for the overall operation of a fund”, which is in line with relevant IOSCO principles.

The SFC nevertheless stress that the intended scope of a “fund manager that is responsible for the overall operation of the fund” remains unchanged. A fund manager would not be able to cite the existence of a governing body to conclude that it is not “responsible for the overall operation of the fund” just because it does not formally make final decisions or enter into legal agreements.

As set out in the Introduction to the FMCC, the FMCC sets out conduct requirements for, and applies to, only persons licensed by or registered with the SFC.

The proposed securities lending and repo requirements were designed to apply to a fund manager that engages in activities on behalf of a fund managed by it, and is not limited in application to a fund manager that is responsible for the overall operation of a fund.

The SFC expects that the fund manager has in place a haircut policy to properly manage counterparty risk arising from engaging in securities lending, repo and reverse repo transactions on behalf of the fund it manages. The fund manager should have a properly designed methodology to calculate haircuts on collateral received. We will not prescribe numerical haircut floors. Fund managers therefore have the flexibility to design their own haircut methodologies.

The SFC will require fund managers to disclose re-use and re-hypothecation data to investors as items for disclosure under the overall requirement to report information relating to securities lending, repo and reverse repo transactions to fund investors.

The SFC expects that a fund manager of any type of fund should adopt a proportionate approach to liquidity management and consider the extent of the applicability of the proposed liquidity risk management requirements to the funds it manages and ensure that its activities are commensurate with the liquidity profiles of those funds.

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