Hong Kong’s Securities and Futures Commission (SFC) issued a circular on 31 July 2017 highlighting potential regulatory concerns identified as a result of the SFC’s ongoing supervision of the activities of licensed asset managers engaged in managing private funds and discretionary accounts. The circular is a reminder that licensed asset managers and their senior management (including the Managers-In-Charge of Core Functions) should be vigilant to ensure that the private funds and discretionary accounts they manage are not being used by clients to circumvent legal or regulatory obligations, that potential conflicts of interest are identified, addressed and managed, that appropriate risk management policies are in place and that licensed asset managers are expected to exercise their own discretion in managing private funds and discretionary accounts.
“Private funds”, in the context of the circular, are open-ended private funds whose investors can redeem from the fund at any time in accordance with the dealing provisions set out in the fund’s offering document. It does not include private equity funds, which by their nature invest in illiquid assets.
The circular notes that, if the SFC finds that private funds or discretionary accounts have been used to fund or conceal improper activities at the expense of investors, the SFC will not hesitate to take action against the asset managers and their senior management for failing to comply with regulatory requirements. The SFC stated asset managers must not turn a blind eye to dubious arrangements and transactions proposed by their clients and should avoid being implicated in any market misconduct or other illicit activities. The circular also notes that the SFC views failure by an asset manager to act in the best interests of its clients and the integrity of the market as a serious matter that directly impugns the fitness and properness of the asset manager.
The circular highlighted several areas of concern to the SFC.
Certain private funds and discretionary accounts had commercially questionable attributes that gave rise to conflicts of interest and that had the potential to conceal shareholdings of clients in listed companies, including the following:
- discretionary account holders held sizeable concentrated stock positions in their accounts and asset managers acted solely at the direction of their clients without exercising investment discretion;
- fund investors or discretionary account holders were substantial shareholders, directors or affiliates of the listed companies invested by the funds or the discretionary accounts; and
- a director of an asset manager was also a director or chief executive officer of listed companies in which funds under the management of the asset manager were invested.
Certain private funds and discretionary accounts had an undue concentration of investments in illiquid stocks and/or stocks issued by a network of smaller interconnected listed companies that could potentially have a material adverse effect on the ability to meet investors’ redemption requests and that could amplify losses in the case of price drops in the underlying investments. The asset managers did not have appropriate and effective risk management policies in place to address these concentration and liquidity risks.
Lastly, the circular reminded asset managers of their obligation under paragraph 12.5 of the Code of Conduct 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.