News & Insights

Risk management and governance during volatile markets

The SFC published the latest Compliance Bulletin (the Bulletin) on 20 January 2020 and emphasized the importance of sound risk management and governance during volatile markets, which are not only relevant to fund managers and brokers but also financial intermediaries with exposure to, for example, illiquid bonds.

The Bulletin also covers:

1. Liquidity and credit risks associated with exposures to illiquid assets along with precautionary responses and good risk management practices.
2. Case studies illustrating risks that may arise in transactions with related parties and other complex financing arrangements – stressing the need for the holding companies and controllers of licensed companies to prudently manage risks at group level.

This article focuses on risk management and governance and highlights liquidity risk for fund managers.

Risk management and governance

Risk management and governance are two of the SFC’s current supervisory priorities based on the speech by Ms. Julia Leung, SFC’s Deputy Chief Executive Officer and Executive Director of Intermediaries, during the 2019 SFC Compliance Forum.

The press release of the Bulletin includes a quote also from Ms. Leung, which emphasizes the importance of stress testing on an ongoing basis:

“Fund managers should conduct stress tests and closely monitor the liquidity profiles of their fund portfolios throughout the entire life cycle of their funds.”

The areas highlighted below serve as good reminders of sound risk management and governance practices, although these are not new and can be found in the SFC’s Code of Conduct for Licensed Persons and Registered Persons, Management for Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the Securities and Futures Commission and the Circular Regarding Measures for Augmenting the Accountability of Senior Management of 16 December 2016.

A sound risk governance structure needs to:

  • be implemented through clear organizational structures, policies/procedures;
  • have roles and responsibilities of senior management that are clearly set out, especially the Manager-In-Charge for risk management; and
  • be commensurate with the nature, size and complexity of the intermediary’s operations, and supplemented by the use of appropriate resources.

Liquidity risk

Liquidity risk arises when there is a mismatch of a fund’s assets and its liabilities. Such risk becomes higher if the fund is concentrated in illiquid assets (particularly illiquid bonds issued by the same group and funds with long or extendable redemption dates) and when there are massive redemptions. Examples of good practices for managing such risks include:

  • effective liquidity risk management policies and procedures;
  • dedicated risk management function covering liquidity risk;
  • appropriate dealing frequency at the fund level;
  • investment diversification; and
  • regular stress tests.

These practices are also not new as the SFC has generally provided such guidance in circulars such as those listed below and the revised Fund Manager Code of Conduct (FMCC). Firms should ensure all applicable provisions and relevant guidance are implemented in their liquidity management process, not just those highlighted in the Bulletin.

  • Circular to management companies of SFC-authorized funds on liquidity risk management of 4 July 2016
  • Circular to licensed corporations: Managing the liquidity risk of funds of 23 August 2019
  • FMCC: risk management (see 1.7.1 to 1.7.3 and 3.11.1 to 3.11.2) and liquidity management provisions (see 3.14.1 to 3.14.3). These requirements are not only applicable to authorized funds but also to private funds.

Licensed firms are advised to read the Bulletin carefully and revisit their risk governance framework.

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