SFC Fund Manager Code of Conduct – Five Important Next Steps

The 18 November 2018 deadline has now passed for the SFC (Securities and Futures Commission) Fund Manager Code of Conduct (FMCC). As with many regulatory change projects, implementation is no longer “the end” of the road; rather, it is a beginning of sorts for Hong Kong’s fund management community.

With the regulation now in force, there are a number of activities firms should be undertaking to ensure ongoing compliance with regulatory expectations. Five key next steps for firms are:

1. Double-check new policies and procedures – By now, firms should have performed a gap analysis between their existing policies and procedures, and the FMCC. This is to identify areas where policies and procedures need to be updated. Firms should be either nearly finished or have completed these updates. This is a good time to review the new policies and procedures to be sure that all is correct and in place.

For example, policies and procedures should be tailored to the firm’s business activities and compliance requirements, especially as it seems likely that the SFC will not tolerate “boilerplate” documentation if found during exams. Other things compliance executives should make sure they have in place include:

  • Clear escalation policies and procedures
  • Documented processes for implementing regulatory change
  • Robust evidence of compliance activities, such as minutes of risk committee meetings
  • Regular, documented, reminders for responsible individuals of their duties under the FMCC
  • Segregation of duties appropriate to the size and complexity of the firm, including outsourcing arrangements for those duties where they make sense

Training staff in the new policies and procedures, as well as in other important elements of the FMCC, is also essential. Compliance should kick off training as soon as possible if they have not already begun this.

2. Be on the lookout for clarifications from the SFC on securities lending – The FMCC’s language around the treatment of securities lending, repurchase agreements, and securities borrowing has led to quite a bit of uncertainty in the market. Generally speaking, most firms are – at the moment – not interpreting typical prime brokerage agreements as “securities lending” as discussed within the regulation. It’s been assumed that the language in the FMCC is aimed at activity outside of normal prime brokerage agreements, such as activity conducted under global master repurchase agreements or global master securities lending agreements.

However, it’s likely that the SFC will clarify the language in the FMCC at some point over the next 12 months to ensure firms are treating this area correctly, so it’s important to be on the look-out for this from the regulator.

3. Listen out for the experiences of other firms with liquidity risk exams – Although firms have performed liquidity risk management for their businesses, the FMCC imposes new regulatory requirements in this area. Appendix 2 of the FMCC details the calculation methodologies the SFC recommends for liquidity risk – firms should select an approach that is right for their operations. For example, firms should be sure that the policies and procedures they have in place around suspending the fund or creating a redemption gate will withstand regulatory scrutiny.

Firms also need to comply with new disclosure rules around fund suspension or redemption gates to investors – this is an area that needs care because it could impact the successful marketing of the fund. All of these liquidity risk management practices will be examined by the SFC for the first time post-FMCC implementation, and compliance executives should listen out for the exam experiences of other firms in this area to understand the approach the regulator is taking.

4. Make sure all disclosure requirements are in place – The SFC FMCC may require some firms to make a significant number of new disclosures. While understanding these requirements should have formed part of the initial gap analysis, it is a good idea to review disclosure needs again at the end of the implementation project. It is possible that, as the firm implemented the FMCC, new needs could have emerged.

Areas that firms should double check include:

  • Material conflicts of interest
  • Cross trades
  • Expected maximum leverage
  • Securities lending/repos/reverse repos
  • Liquidity management
  • Side letters
  • Custodial risks
  • Termination information
  • Side pocket information
  • Fees and charges in more detail
  • Transactions where the fund manager is acting as principal

The SFC is being reasonable about how this information needs to be disclosed. Ideally, firms should include all required information in the offering document. However, firms do not need to re-open their offering document if they can prove that they have disclosed this information through another document that has been received by all required parties.

5. Keep an exceptions log – If firms have not already put in place an exceptions log, they should do so immediately. This log should document the compliance exception, what happened and why, and how the breach of policy was handled by the firm. The exceptions log is a compliance officer’s best friend – it shows that the firm is monitoring its business activities, and provides the SFC with reassurance that breaches are being detected and managed appropriately. It’s unlikely that something logged in this way would result in legal liability or prosecution for individuals or the firm.

Although the FMCC deadline has passed, ensuring this piece of regulatory change happens correctly will continue to be an ongoing process for most impacted firms.

Derek McGibney is Director for Asia at ACA Compliance Group, and supports the regulatory needs of investment firms operating locally or entering the market from other jurisdictions.

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