Tips for regulatory inspections

We published an item on regulatory inspection priorities for 2016 in early February. With the second half of 2016 approaching, we would like to further highlight some of the areas of focus in recent inspections.

1. Liquidity risk management

The Fund Manager Code of Conduct is under review by the SFC and we anticipate that more specific liquidity monitoring requirements may be introduced. Licensed entities should ensure they have specific liquidity risk management policies in place for the portfolios they manage and that the liquidity of those portfolios is regularly monitored. Any deviation from the liquidity risk management policy needs to be justified and should be recorded with details of the reasons for the deviation from the policy.

2. Portfolio Valuation

Portfolios are commonly valued by reference to last traded prices obtained from public sources. However, where investments are illiquid or thinly traded, particularly if the relevant security has not been traded recently so that the last traded price may be stale, managers should consider whether a fair value adjustment should be made.

3. Electronic trading and systems

Licensed entities are required to ensure that electronic tradings systems they use are robust (see Circular to all Licensed Corporations on Internet Trading – Internet Trading Self-Assessment Checklist). This obligation applies not only to the licensed entity’s own systems but also to the systems which they know (or ought reasonably to be aware) will be used by third parties in connection with their business. For example, many brokers used by fund managers use algorithmic systems to execute trades, and the SFC expects such managers to carry out due diligence on the broker’s systems.

Internal policies and controls need to be reviewed regularly to take account of internal and external changes. Compliance personnel should pose the following questions:

• Is there a proper policy in place?
• Is the policy well-promoted to staff?
• Do day-to-day operations in fact comply with the policy?
• Is there a proper and traceable audit trail?
• Is adequate compliance testing undertaken?

For more hints on preparing for an inspection, please refer to our previous article ‘How ready are you for the SFC’s routine inspection call’ published on 12 January 2015.