Boards and senior management (including Managers-in-Charge of Core Functions (MICs)) of asset managers have been called on by the SFC (31 July 2017 circular) and the HKMA (2 August 2017 circular) to ensure they maintain adequate management oversight of their firm's business activities and to ensure maintenance of appropriate standards of conduct and proper risk management measures after the SFC identified a number of potential regulatory concerns.
The SFC has said that it will continue to closely monitor asset managers and will not hesitate to take action against any licensed corporations and their senior management for failure to comply with regulatory requirements.
Irregularities and deficiencies in managing private funds and discretionary accounts
During the course of its supervision of licensed corporations engaged in managing private funds and discretionary accounts (asset managers), the SFC identified a number of questionable practices and risk management concerns, including:
- discretionary account holders having sizeable concentrated stock positions and asset managers acting solely at the discretion of their clients;
- related party acquisition or disposal of listed company shares by bought and sold notes;
- instances where fund investors or discretionary account holders were related (eg, as a substantial shareholder, director or affiliate) to the listed companies invested in by the funds or discretionary accounts;
- funds and discretionary accounts with concentrated, illiquid and interconnected investments;
- uncollateralised loans arranged for a fund from the asset manager's other funds to meet margin calls on leveraged stock trading;
- a related party of an asset manager making a loan to a fund with an extremely high one-off financing charge; and
- a fund investor related to an asset manager being given preferential treatment allowing the investor to redeem his holding before negative adjustment was applied to the fund.
Through these examples, the SFC has highlighted the importance of:
- acting in the best interests of the integrity of the market;
- risk management, including liquidity risk management; and
- acting fairly and avoiding conflicts of interest.
The SFC has also reminded asset managers of their obligation to report to the SFC any material breach, infringement or non-compliance with the market misconduct provisions of the Securities and Futures Ordinance which they reasonably suspect may have been committed by their clients. Turning a blind eye to dubious arrangements and transactions proposed by clients (eg, arrangements such as those referred to above that may conceal the shareholding of the fund investors or the discretionary account holders in listed companies) may instead implicate asset managers in any market misconduct or other illicit activities.
Accordingly, asset managers are reminded by the SFC to critically examine arrangements and transactions, including performing proper client due diligence.
The SFC's circular reminds asset managers that they must have in place and maintain effective risk management policies and procedures to identify and manage the risks to which each fund or discretionary account is or may be exposed, including concentration and liquidity risks. In this regard, the SFC expects asset managers to manage the liquidity risks of funds under management to ensure that investors' redemption requests are able to be met in accordance with the terms set out in the funds' offering documents.
The Financial Conduct Authority has similarly been focusing on liquidity risks of funds, having recently published the findings from a review of property funds and liquidity risks (see our e-bulletin here). This follows the publication of a discussion paper (DP17/1) on 8 February 2017 in which the FCA considered some of the risks that arise when consumers invest in open-ended investment funds to gain exposure to illiquid assets, such as real estate or infrastructure. In particular, the FCA noted that the interests of investors who wish to withdraw from a fund can be hard to reconcile with the interests of investors who wish to remain invested where there is a significant increase in redemption demand, similar to that experienced in the aftermath of the UK’s vote in June 2016 to leave the European Union (ie, Brexit).
Increased regulatory focus on asset management industry and senior management responsibility
In Hong Kong, the asset management industry has come under increasing regulatory focus as the SFC seeks to ensure that its regulations are properly benchmarked to evolving international standards as part of the SFC's broader initiative to enhance Hong Kong's position as a major international asset management centre. As a result, enhanced regulation is proposed through changes to the Fund Manager Code of Conduct and the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission aimed at better protecting investors' interests and ensuring market integrity (see our e-bulletin here).
The introduction of the SFC's Manager-In-Charge Regime (see our e-bulletin here) has also heightened the accountability of the senior management of all asset managers licensed by the SFC. In particular, the SFC expects the board and other senior managers (including MICs) to bear primary responsibility for ensuring the maintenance of appropriate standards of conduct, including but not limited to acting fairly and in the best interests of their clients and the integrity of the market. As referred to in the SFC's 31 July 2017 circular, any failure in this regard will be considered a very serious matter by the SFC and will directly impugn the asset managers' and their senior management and MIC's fitness and properness.
Asset managers are encouraged by the regulators to review the areas of concern discussed in the SFC's 31 July 2017 circular (and referred to above) and give priority to strengthening their supervisory and compliance programmes to ensure compliance with all applicable regulatory requirements. Failure to do so in the current regulatory environment is likely to lead to an increased enforcement focus.