The Hong Kong Securities and Futures Commission (SFC) introduced new requirements and enhanced existing requirements in the Fund Manager Code of Conduct (FMCC). These amendments became effective November 17, 2018 and August 17, 2018, respectively. Changes have been made to bring the existing regulations of fund managers in Hong Kong in-line with the recommendations of the International Organization of Securities Commissions (IOSCO) and the Financial Stability Board (FSB).
In response to reports from the FSB and to address shadow banking risks, the revised FMCC places new obligations on fund managers when a fund under their management “engages” in securities lending, repo and reverse repo transactions. Specifically, a fund manager decides that securities lending should be a fund activity, or is materially involved in determining a securities lending mandate or in actual lending activities. These proposals apply to private as well as public funds.
The provisions in the updated FMCC include the following:
- Securities Lending: Specifically, the fund manager will need to put in place some effective and acceptable policies
- Collateral valuation and management policy: This policy requires that collateral and loaned securities are marked to market daily - to the extent practicable.
- Eligible collateral and haircut policy: This should enable the fund manager to determine the types of acceptable collateral and methodology to calculate haircuts, mitigating counterparty risk.
- Cash collateral reinvestment policy: This is to ensure that assets held in cash collateral reinvestment portfolio are sufficiently liquid to meet the expected and unexpected recalls of cash collateral.
- Conflicts of Interest: A fund manager must take all reasonable steps to identify and prevent any actual or potential conflicts of interest. This implies that a fund manager must conduct transactions in good faith and disclose any material interest or conflict to fund investors.
- Risk management: The fund manager is required to have a robust risk management strategy to counter potential losses from unwarranted adverse market movements and to keep other risks like operational risks, counterparty risks, etc. under control.
- Disclosure to fund investors: SFC also expects fund managers to provide detailed information regarding fund’s securities lending, repo and reverse repo transactions to investors - at least annually.
These FMCC provisions are applicable only to fund managers responsible for overall operation of the fund. The following information needs to be disclosed to the investors:
- Custodians
- The FMCC requires segregation of fund assets from those of the fund manager and, unless they are held in an omnibus account, from the assets of the fund manager’s affiliates and other clients.
- A fund manager needs to ensure that the custody arrangements and any associated material risks are disclosed to investors.
- Liquidity risk management
- A fund manager needs to apply stress testing for regular monitoring of the liquidity risk of the fund. An explanation of liquidity management tools, facts and material terms vis-à-vis redemptions in side pockets and other preferential treatment should be disclosed to the investors.
- Disclosure of leverage
- The FMCC requires a fund manager to disclose to fund investors the expected maximum level of leverage that it may employ on behalf of each fund it manages and the basis of calculation of leverage that should be reasonable and prudent.
