Long Awaited SFC Consultation Conclusions on Asset Management and Revision of Fund Manager Code of Conduct (FMCC)

11 December 2017

ESMA

In November 2017, the SFC issued their consultation conclusion on proposals to enhance asset management regulation and point-of-sale transparency in Hong Kong. This represents one of the biggest changes for asset managers in 2017, and so it is important that all managers caught now prepare and react to the changes. The SFC also simultaneously launched a further consultation on disclosure requirements applicable to discretionary accounts.

The most important part of this consultation conclusion is the revised Fund Manager Code of Conduct (FMCC). This will impact all Type 9 license holders in the market. The revised FMCC will become effective in 17 November 2018.  The changes in the FMCC covers several areas of fund management activities and the relevant disclosure requirements, and therefore fund managers should review and assess their compliance manual, risk management policy, client agreement, and offering documents and revise the documentations as necessary to comply with the revised FMCC before 17 November 2018.

The main changes and new additions to the FMCC in summary are:

  1. “Responsible for the overall operation of the fund”
  • Certain sections of the FMCC are only applicable to the fund manager which is responsible for the overall operation of the fund. The SFC clarified that a fact-based review should be conducted to identify who is responsible for the overall operation of the fund. The SFC has given an example that “where the representatives of the fund manager or its subsidiaries constitute a majority of the fund board, then the fund manager may be considered to be responsible for the overall operation of the fund.  The SFC will issue further FAQs to elaborate when a fund manager will be classified as “responsible for the overall operation of the fund”.
  1. Discretionary accounts
  • The revised FMCC specifies that the FMCC applies to discretionary accounts managers. Appendix 1 of the revised FMCC lists out additional requirements that discretionary account managers will need to comply with along with the requirements in the FMCC that are not applicable to discretionary account managers.

Additional requirements include:

  • The discretionary account manager should ensure a client agreement is in place prior to any service/transaction taking place. The minimum content of a discretionary client agreement has been updated as well (for example, client consent is required when a discretionary account manager wants to receive soft commission/retain cash rebates).
  • Discretionary account managers should review the accounts’ performance at least twice a year, and provide valuation reports to clients at least on a monthly basis.
  1. Securities lending and repos
  • New requirements are applicable to hedge fund managers who engage in securities lending, repo and similar OTC transactions on behalf of the funds managed by them. If a manager mainly borrows securities from prime brokers instead of engaging in lending activities careful consideration will be needed to determine if the new requirements apply. This is because the requirements are aimed at governing the collateral management of fund managers. Fund managers are expected to act with due skill, care and diligence in the selection, appointment and ongoing monitoring of the third party (e.g. prime brokers).
  • The revised FMCC requires disclosure of a summary of the securities lending, repo and reverse repo transaction policy and risk management policy to fund investors. The SFC clarifies that the disclosure does not need to made in the offering documents of the funds.
  • The SFC expects fund manager to have a properly designed methodology to calculate haircuts on collateral received.
  1. Custodian/safe custody of fund assets
  • The majority of the detailed requirements are applicable to the fund manager that is responsible for the overall operation of a fund. For those who are not responsible, they will still need to ensure fund assets are segregated from the assets of the fund managers.
  • The revised FMCC lists out the assessment criteria of a qualified custodian to be performed during third party due diligence, including appropriate segregation arrangements, legal/regulatory status, financial resources and conflicts of interest management.
  • The SFC also requires a custody agreement to be in place.
  1. Liquidity risk management
  • The SFC expects the fund manager to perform liquidity stress testing on its funds on an ongoing basis to assess the impact of plausible severe adverse changes in market conditions.
  • Disclosure of the liquidity risk and liquidity management policies is required, and can be made either in the fund’s offering documents or made freely available to fund investors.
  1. Disclosure of leverage
  • The SFC requires fund managers to disclose the expected maximum leverage of the fund(s) they manage and expects the disclosure to be based on a reasonable and prudent calculation methodology, which is fair and not materially misleading.
  1. Fund portfolio valuation
  • The SFC states that valuation methodologies should be consistent for similar types of fund assets.
  • The internal audit department or external auditor would be appropriate to act as the independent party required for the annual review of the valuation policies and procedures.
  1. Risk management
  • The SFC has set out the suggested risk management control procedures for funds in Appendix 2 to the revised FMCC, covering the following risks:

– Market risk
– Liquidity risk
– Issuer and counterparty credit risk
– Operational risk

  • The SFC also expects fund managers to review their business continuity plan at least annually.
  1. Personal account dealing
  • Relevant persons in the fund manager are required to disclosed their investment holdings semi-annually. Duplicated statements are required to be submitted to the fund manager within a defined timeframe.

Bovill can help you in assessing whether you will be classified as the fund manager which is responsible for the overall operation of the fund, revising your existing compliance policies and procedures, and drafting new compliance and/or risk management policies to comply with the revised FMCC.  

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