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In our last newsletter article we discussed our observations from compliance “health checks” on SFC licensed hedge fund managers, so in this article we will focus on the issues we commonly identify in health checks on private equity managers licensed by the Securities and Futures Commission (SFC).
|1.||Insufficient record of investor’s investment horizon. Private equity funds are generally only suitable for investors with a very long term investment horizon but we do find that some private equity managers have not kept records which show that they have carefully considered the investor’s investment horizon as part of the suitability assessment. Suitability is of course never required for institutional professional investors but it may be with corporate investors, and will often be required where the investor is a single family office. Compliance with the suitability obligation remains one of the SFC’s top priorities. When suitability applies, all private equity firms doing fundraising need to assess whether liquidity is a major concern for the prospect, and whether the prospect will be able to honour capital calls, before taking an investment.|
|2.||Deficiencies in portfolio company valuations. Some private equity firms do not seem to keep track of the methods they use for valuations (where they have discretion in this regard) and/or the basis for the assumptions they make in the valuation process, whilst others rely too much on valuations done by third parties. The valuation of a portfolio company requires a great deal of professional judgement because market prices are not available. It is important that private equity firms make sure that fund assets are valued fairly and accurately and that they keep records showing how the valuations were derived. If third party service providers are used, private equity firms need to regularly review the valuation services because they are ultimately responsible for the valuations. They obviously do not want to be caught having over-valued fund assets!|
|3.||Inadequate investor take-on policies/procedures and record keeping. We find that some private equity firms do not really have investor take-on policies and procedures that cover the steps required for taking on different investor types, whilst others do not collect all the documents required for KYC or professional investor assessment purposes. When private equity firms are inspected by the SFC, the SFC typically reviews how those firms establish and then verify the status of the investors to which the Hong Kong firm has marketed and the documentary evidence obtained during this process, so private equity firms need to ensure that they have detailed investor take-on procedures in place, and that proper reviews of the KYC / CDD documents are conducted.|
|4.||Not able to clearly state individual roles and responsibilities within the licensed entity. Most of our Hong Kong private equity clients are part of global groups, and a very common observation from our health check interviews with the Responsible Officers (ROs) and Managers-in-Charge (MICs) is that many interviewees only describe their responsibilities as representatives of other group entities and not as ROs/MICs of the Hong Kong licensed entity. Being members of senior management, ROs and MICs need to clearly understand their roles and responsibilities at the licensed firm and be able to instill confidence in the SFC that they are on top of their own legal and regulatory obligations.|
|5.||Potential licensing requirements of overseas visitors not evaluated. We understand from some of our private equity health check compliance staff interviews that the compliance team does not always consider the SFC licensing implications of overseas colleagues visiting Hong Kong for investor meetings. There should always be a licensing assessment even if the visitors will be accompanied by licensed individuals and the conclusions should be documented. Where no temporary Hong Kong licence will be required, the person should be given “dos and don’ts” so they stay in the green zone while they are in Hong Kong.|
If you would like advice on the source of any of the obligations referred to above or to discuss our health check service, please do not hesitate to contact Jane McBride (email:firstname.lastname@example.org@deacons.com
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