Hong Kong Securities and Futures Commission (SFC) highlights operating, control and compliance deficiencies in asset management industry

Size: px

Start display at page:

Download "Hong Kong Securities and Futures Commission (SFC) highlights operating, control and compliance deficiencies in asset management industry"

Walter Hamilton
5 years ago
Views:

1 Hog Kog Securities ad Futures Commissio (SFC) highlights operatig, cotrol ad compliace deficiecies i asset maagemet idustry Ae-Marie Godfrey Abstract Purpose To examie the ie commo areas of o-compliace i maagig ivestmet fuds ad discretioary accouts, detailed i a Hog Kog Securities ad Futures Commissio (SFC) circular dated September 15, 2017, directed at SFC-licesed asset maagers. Desig/methodology/approach Discusses a July 2017 circular idicatig the SFC s geeral cocers ad aalyzig the followig ie commo areas of o-compliace cited i the September 15, 2017 circular: (1) iappropriate receipt of cash rebates givig rise to apparet coflicts of iterests, (2) failure to follow ivestmet-suitability ad discretioary accout madates durig solicitatio, (3) failure to implemet liquidity-risk maagemet processes, (4) deficiecies i goverace structures ad fairvaluatio procedures, (5) deficiecies i systems for esurig best executio, (6) failure to safeguard fair order allocatio, (7) iadequate cotrols for protectio of cliet assets, (8) iadequate systems to comply with ivestmet restrictios, ad (9) iadequate safeguards to address market miscoduct risk. Fidigs The ie examples of o-compliace provide a useful isight ito key problem areas idicated to curretly be of particular cocer to the SFC. Practical implicatios All SFC-licesed asset maagers would be well advised to revisit their iteral goverace structures ad operatioal policies ad procedures i order to esure that they are compliat with applicable stadards ad requiremets. Origiality/value Practical guidace from a lawyer with extesive experiece advisig ivestmet maagers ad advisers, fud admiistrators, trustees ad other fud service providers o ivestmet fud-related issues. Keywords Hog Kog, Securities ad Futures Commissio, Compliace, Asset maagers, Iteral goverace structures, Operatioal policies ad procedures Paper type Techical paper Ae-Marie Godfrey (aemarie.godfrey@akigump. com) is a parter at Aki Gump Strauss Hauer & Feld LLP, Hog Kog, Hog Kog. Further to geeral cocers raised i a circular issued by the Hog Kog Securities ad Futures Commissio ( SFC ) i late July 2017[1], the SFC issued a further circular o September 15, 2017, specifically directed at SFC-licesed asset maagers (the Circular )[2]. The Circular was based o fidigs from recet routie ispectios of 250 licesed corporatios. Further, the Circular addressed a umber of issues idetified as part of the SFC s supervisio of licesed asset maagers ad their maagemet of private fuds ad discretioary accouts. The Circular provided illustrative examples of o-compliace observed by the SFC. The examples highlighted by the SFC provide a useful isight ito key problem areas that are of particular cocer to the SFC. Aki Gump Strauss Hauer & Feld LLP. DOI /JOIC VOL. 19 NO , pp , Emerald Publishig Limited., ISSN j j JOURNAL OFINVESTMENTCOMPLIANCE PAGE 63

2 No-compliace Issue 1: iappropriate receipt of cash rebates givig rise to apparet coflicts of iterest The SFC highlighted the practice of maagers receivig ad retaiig cash rebates from executio brokers. The SFC cosidered the retetio by maagers of broker rebates as a potetial or perceived coflict of iterest. This is due to the risk that such rebates may icetivize a maager to trade more frequetly with the broker tha: might be cosistet with the fud s ivestmet strategy; ad/or might otherwise be i the best iterests of that fud. The SFC highlighted a situatio that it foud where rebates had amouted to 7 percet of the et asset value of the relevat fud. To address the coflicts of iterest iheret i cash rebate practices, fud maagers should esure that specific cosets have bee obtaied from their cliets[3]. No-compliace Issue 2: failure to esure suitability of fuds or discretioary accout madates whe makig solicitatios or recommedatios of fuds uder their maagemet or providig discretioary accout maagemet services to cliets As part of the amedmets to the SFC s Code of Coduct for Persos Licesed by or Registered with the Securities ad Futures Commissio (the Code ) adopted i March 2016[4] for licesed corporatios, the Code ow requires a full ivestor suitability aalysis i respect of all high-et-worth idividuals ad usophisticated corporates. Accordigly, whe itermediaries are recommedig or solicitig a product to such categories of ivestors, such itermediaries are required to esure that the suitability of the recommedatio or solicitatio for the cliet is reasoable i all circumstaces. Furthermore, itermediaries are ow required to iclude madatory wordig i cliet agreemets, cofirmig that: where a fiacial product is solicited or recommeded, that fiacial product must be reasoably suitable for the cliet havig regard to the cliet s fiacial situatio, ivestmet experiece ad ivestmet objectives; o other provisio of the cliet agreemet or ay other documet siged by the cliet may derogate from the suitability clause; ad The requiremet for a writte cliet agreemet cotaiig the foregoig clause caot be waived by high-et-worth idividuals or usophisticated corporates. The SFC cited examples of maagers who had iappropriately waived Code requiremets. The previous provisios of the Code that permitted the waiver of certai obligatios uder the Code by ivestors who are high-et-worth idividuals or which are usophisticated corporates have bee removed. The iclusio of this poit i the Circular serves as a remider to asset maagers that the SFC views the suitability requiremet as beig applicable to asset maagers. No-compliace Issue 3: failure to put i place a proper liquidity risk maagemet process to esure that liquidity risks of fuds ad discretioary accouts uder maagemet are adequately addressed The SFC issued a circular i late 2016 outliig liquidity-risk-maagemet procedure requiremets for maagemet compaies of SFC-authorized fuds. PAGE 64j j JOURNAL OF INVESTMENT COMPLIANCE VOL. 19 NO

3 I the Circular, the SFC reiterated that asset maagers maagig SFC-authorized fuds should esure that policies ad procedures are supported by strog ad effective goverace ad operatioal capabilities. I additio, as part of the SFC s ogoig cosultatio process for the SFC s Fud Maager Code of Coduct ( FMCC )[5], the Circular proposed to ehace the requiremets relatig to liquidity-risk maagemet for asset maagers. The SFC cited examples of maagers who had ot exercised due care, skill ad diligece i assessig the liquidity profile of certai fuds assets ad liabilities. These maagers simply relied o iformatio show o their firms portfolio maagemet systems ad made assessmets that did ot take ito accout the historical ad expected redemptio patter of a fud or were based o a sigle quatitative metric or qualitative factor. No-compliace Issue 4: deficiecies i settig up a proper goverace structure ad implemetig comprehesive policies ad procedures for fair valuatio of assets The Circular serves as a remider to asset maagers of the duty to esure the proper valuatio of fud assets. SFC-licesed asset maagers are subject to the geeral requiremet to esure that fud assets are valued o a regular basis, i accordace with the costitutive documets of the fud ad to disclose to ivestors the basis for the valuatio[6]. The Circular highlighted istaces i which maagers did ot have proper goverace structures i place ad had implemeted valuatio policies that were deemed to be deficiet i light of requiremets uder the Code ad uder the SFC s separate circular issued o July 20, 2015[7]. Examples give iclude: for suspeded bods ad stocks, o assessmet of whether historical values reflect the fair value of such assets; a valuatio policy lackig appropriate policies to determie whether fair value adjustmets are ecessary; ad a valuatio policy imposig too high a trigger for escalatig fair valuatio issues to the iteral valuatio committee. No-compliace Issue 5: deficiecies i systems ad cotrols for esurig best executio The SFC oted deficiecies i the systems ad cotrols of some asset maagers i relatio to best executio. SFC-licesed fud maagers are required to execute cliet orders o the best available terms, takig ito accout the relevat market at the time for trasactios of the kid ad size cocered[8]. Asset maagers should put i place adequate systems ad cotrols ad should take ito accout factors such as price, costs, speed, likelihood of executio ad settlemet, size ad ature of the trade, ad other relevat cosideratios. The SFC highlighted operatioal deficiecies i terms of allocatio of trades by maagers: to brokers offerig the best soft-dollar arragemets; other tha i accordace with the results of broker evaluatio scorig; ad without specifyig a miimum umber of quotatios required for the trasactio. The SFC geerally oted that asset maagers should be midful of potetial coflicts of iterest arisig whe directig trades to executio brokers. VOL. 19 NO j JOURNAL OF INVESTMENT COMPLIANCE j PAGE 65

4 No-compliace Issue 6: failure to safeguard fair order allocatio The SFC also idetified deficiecies i fair order allocatio arragemets amog some asset maagers. The FMCC imposes a requiremet o all fud maagers to: esure that all cliet orders are allocated fairly; make a record of the iteded allocatio before a trasactio is effected; ad esure that a executed trasactio is allocated promptly i accordace with the stated itetio, except where the revised allocatio does ot disadvatage a cliet ad the reasos for the re-allocatio are clearly documeted[9]. The SFC provided examples of asset maagers that maaged multiple fuds ad discretioary accouts, ad failed to esure compliace with the requiremets of the FMCC, due to: failure to maitai the required records; failure to demostrate fair allocatio betwee accouts (i particular, betwee a house accout ad a cliet accout); ad failure to properly match pricig with order iput. The SFC reiterated the eed for asset fud maagers maagig multiple fuds to implemet proper goverace structures, policies ad procedures to gover order allocatio; maitai clear records of the basis of allocatio; ad esure that ay deviatio from iteral policy is clearly documeted ad subject to seior maagemet review ad approval. No-compliace Issue 7: iadequate systems ad cotrols i relatio to protectio of cliet assets The SFC observed that, cotrary to the duty uder the FMCC[10] to esure that cliet assets are properly safeguarded, some asset maagers had failed to implemet adequate systems ad cotrols to properly protect the assets of the fuds ad discretioary accouts to which they have bee etrusted. The SFC highlighted the followig commercial practices as beig iadequate to meet the safeguardig requiremet imposed uder the FMCC: appoitmet of a sole authorized sigatory (with o secodary sigatory) to effect otrade trasfers of fud assets i ad out of brokerage accouts or custodia accouts; ad failure to demostrate regular recociliatios of cash ad ivestmet holdigs with exteral service providers i order to detect omissios, errors or missig assets. The SFC reiterated the eed for asset maagers to implemet appropriate ad effective cotrols ad procedures i order to protect cliet assets from potetial theft, fraud ad other acts of misappropriatio, ad to esure the proper safeguardig of assets uder their maagemet. No-compliace Issue 8: iadequate systems ad cotrols for esurig compliace with ivestmet restrictios ad guidace The SFC highlighted failures by asset maagers to impose proper ad adequate systems ad cotrols so as to esure that ivestmets were compliat with ivestmet restrictios ad guidelies. Examples of iadequate practices iclude: PAGE 66j j JOURNAL OF INVESTMENT COMPLIANCE VOL. 19 NO

5 ability for a trader to override system-geerated violatio alerts without proper justificatio; ad failure to properly implemet automated pre-trade ad post-trade ivestmet restrictios checkig ad, i particular, failure to carry out post-trade ivestmet restrictios checkig. The SFC reiterated the eed for asset maagers to implemet effective systems i order to esure that all trasactios performed with respect to a fud are carried out i accordace with that fud s stated objectives, restrictios ad guidelies. The SFC particularly highlighted the eed to esure that automated ivestmet restrictio checks are properly verified. No-compliace Issue 9: iadequate systems ad cotrols to address the risk of market miscoduct Market miscoduct is addressed i Parts XIII ad XIV of the Securities ad Futures Ordiace ( SFO ) ad covers the crimial ad civil offeces of isider dealig, false tradig, price riggig, disclosure of iformatio about prohibited trasactios, disclosure of false or misleadig iformatio iducig trasactios ad stock market maipulatio[11]. The SFC cosiders market miscoduct offeces as particularly grave. The SFC reiterated the eed for asset maagers to implemet adequate iteral systems ad cotrols i order to prohibit ad prevet market miscoduct. Such systems ad cotrols would ordiarily be documeted i a dedicated chapter i the asset maager s compliace maual, dealig with moitorig, idetificatio, escalatio, ad, where ecessary, ivestigatio ad disciplie. I additio, the SFC expects that asset maagers will esure that relevat staff receives proper traiig so that they are familiar with the correct protocols. Examples of iadequate policies ad procedures iclude: failure to implemet proactive measures to idetify irregular trades (otwithstadig the existece of iteral policies goverig the reportig of isider iformatio); ad absece of procedures for the appoitmet ad moitorig of exteral expert etwork firms as part of the research process for securities. Coclusio The Circular highlights areas of particular cocer to the SFC, ad it is i lie with the Eforcemet Divisio s objective of sigalig to the asset maagemet idustry regardig issues about which it is dissatisfied. I light of the issuace of the Circular, all SFC-licesed asset maagers would be well advised to revisit their iteral goverace structures ad operatioal policies ad procedures i order to esure that these are compliat with applicable stadards ad requiremets. I particular, SFC-licesed asset maagers would be well advised to esure that their firms do ot exhibit ay of the deficiecies highlighted i the Circular. The Circular is also a remider that the SFC is a vigilat regulator ad carefully moitors asset maagers i order to esure compliace with stadards imposed by the SFO, the Code, the FMCC ad the various circulars, guidelies ad FAQs issued by the SFC from time to time. Notes 1. Circular to Licesed Corporatios Egaged i Asset Maagemet Busiess: Irregularities ad Deficiecies i Maagig Private Fuds ad Discretioary Accouts, available at: edistributioweb/gateway/en/circular/doc?refno=17ec48 VOL. 19 NO j JOURNAL OF INVESTMENT COMPLIANCE j PAGE 67

6 2. Circular to Licesed Corporatios Egaged i Asset Maagemet Busiess: Commo Istaces of No-Compliace i Maagig Fuds ad Discretioary Accouts, available at: edistributioweb/gateway/en/circular/doc?refno=17ec57 3. See Sectio 13.1 of the Code of Coduct for Persos Licesed by or Registered with the SFC (Jue 2017). 4. As covered comprehesively i the separate cliet alert, SFC Publishes Circulars ad Updates FAQs o the Triggerig of, ad Compliace with, Suitability Obligatios (Jauary 2017), availableat: www. akigump.com/e/ews-isights/sfc-publishes-circulars-ad-updates-faqs-o-the-triggerig-of.html 5. See SFC Cosultatio Paper o Proposals to Ehace Asset Maagemet Regulatio ad Poit-ofsale Trasparecy (November 2016), available at: cosultatio/opefile?refno=16cp5 6. See Paras. 5.3 ad 5.4 of the SFC Fud Maager Code of Coduct. 7. See SFC Circular to Maagemet Compaies ad Trustees/Custodias of SFC-authorized Fuds Relatig to Fair Valuatio of Fud Assets issued o July 20, See Para. 3.2 of the SFC Fud Maager Code of Coduct. 9. See Para. 3.4 of the SFC Fud Maager Code of Coduct, which addresses order allocatio. See also Para of the SFC Fud Maager Code of Coduct, which addresses dealig for house accouts. 10. See Para. 4.1 of the SFC Fud Maager Code of Coduct. 11. See Sectio 245 of the Hog Kog Securities ad Futures Ordiace (Cap. 571). Correspodig author Ae-Marie Godfrey ca be cotacted at: ae-marie.godfrey@akigump.com For istructios o how to order reprits of this article, please visit our website: Or cotact us for further details: permissios@emeraldisight.com PAGE 68j j JOURNAL OF INVESTMENT COMPLIANCE VOL. 19 NO

SEC Adopts. Amendments. To The Advisers Act Custody Rule SECURITIES LAW ALERT MARCH 2010

SEC Adopts. Amendments. To The Advisers Act Custody Rule SECURITIES LAW ALERT MARCH 2010 MARCH 2010 SEC Adopts Amedmets To The Advisers Act Custody Rule The Securities Exchage Commissio ( SEC ) has adopted amedmets to Rule 206(4)-2 (the Custody Rule ) uder the Ivestmet Advisers Act of 1940