SFC’s recent enforcement actions against two Hong Kong-based managers for failures to comply with the Fund Manager Code of Conduct

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Authored by: Ming Chiu Li and George Ho

Introduction

Recently, the enforcement arm of the Securities and Futures Commission (SFC) took action against two Hong Kong-based fund managers for their failure to fulfill their obligations under the Fund Manager Code of Conduct (FMCC). This article will discuss these recent cases, highlighting implications that may arise from non-compliance for asset managers.

Case 1: Hong Kong-based investment manager

The SFC investigated a Hong Kong-based investment manager of a Cayman-incorporated fund (the Investment Manager) for failures related to its fund management activities.

The SFC’s investigation revealed that, at the material time, the Investment Manager invested approximately 90% of the fund’s net asset value into financial instruments linked to a Mainland property developer, despite identifying various downside factors in its own analysis. This contravened paragraph 1.2(d) and paragraph 1.7.1 of the FMCC, which require fund managers to maintain appropriate risk management structures and procedures aligned with the firm’s characteristics and investment strategies. Fund managers also have a duty to establish effective policies, procedures, and designated risk management functions to promptly identify, quantify, and manage financial and non-financial risks associated with a fund.

As a result, the SFC reprimanded and fined the Investment Manager HK$5.2 million for, among other things, breaching the relevant FMCC provisions. Furthermore, the licence of the responsible officer of the Investment Manager was suspended for 10 months due to his failure to fulfill his duties.

Case 2: Hong Kong-based asset management arm of a Mainland company

The second case involves a Hong Kong-based asset management arm of a Mainland company (the Fund Manager) and its failure to discharge its duties as the manager of a Cayman-incorporated fund.

The SFC found that contrary to the fund’s investment objective and strategy, the portfolio of the fund held only a limited number of stocks during the relevant period. Additionally, it held highly concentrated positions in two Hong Kong-listed stocks, one of which was not on the permitted securities list approved by the Fund Manager’s senior management. The Fund Manager’s internal controls were also inadequate in ensuring compliance with the investment mandate.

The Fund Manager’s failures as outlined above are inconsistent with paragraph 3.1 of the FMCC, which provides that fund managers should ensure that all transactions conducted on behalf of each fund align with the fund’s stated investment strategy, objectives, and restrictions as specified in the fund’s constitutive and relevant documents. To achieve this, fund managers should establish effective and properly-implemented procedures and controls.

Consequently, the SFC publicly reprimanded and fined the Fund Manager HK$2.8 million.

Fund managers’ obligations under the FMCC

Fund managers are reminded to pay particular attention to the following obligations under the FMCC, as highlighted in the cases above: –

• Organisation and Management Structure

A fund manager should maintain: –

– satisfactory internal controls and written compliance procedures which address all applicable legal and regulatory requirements.

– satisfactory risk management governance structure and procedures commensurate with the nature, size, complexity and risk profile of the firm and the investment strategy adopted by each of the funds under its management.

(Paragraphs 1.2(c) and 1.2(d) of the FMCC)

• Risk Management

A fund manager should establish and maintain effective policies and procedures as well as a designated risk management function to identify and quantify the risks, whether financial or otherwise, to which the fund manager and, if applicable, the funds are exposed. The fund manager should take appropriate and timely action to contain and otherwise adequately manage such risks.

(Paragraph 1.7.1 of the FMCC)

• Fund Management – Investment within Mandate

A fund manager should ensure that transactions carried out on behalf of each fund are in accordance with the fund’s stated investment strategy, objectives, investment restrictions and guidelines, whether in terms of asset class, geographical spread or risk profile, as set out in the respective constitutive and/or relevant documents of the funds managed by the fund manager. In this connection a fund manager should have in place effective and properly-implemented procedures and controls.

(Paragraph 3.1 of the FMCC)

• Fund Management – Liquidity Management

A fund manager should establish, implement and maintain appropriate and effective liquidity management policies and procedures to monitor the liquidity risk of the fund, taking into account the investment strategy, liquidity profile, underlying assets and obligations, and redemption policy of the fund.

(Paragraph 3.14.1(a) of the FMCC)

Furthermore, fund managers and their licenced personnel must also comply with the General Principle 2 of the Code of Conduct for Persons Licenced by or Registered with the Securities and Futures Commission and act with due skill, care and diligence, in the best interest interests of its clients and the integrity of the market in conducting its business activities.

Key take-aways

Our observation is that a fund’s holding of concentrated illiquid positions will be scrutinised closely by the SFC, against the fund’s stated investment policy and the fund manager’s general duty to diversify investments and manage risks for portfolios under their management. It is noteworthy that in a circular issued in 2019 (accessible here), the SFC highlighted the importance of managing liquidity risks, implementing robust risk management systems, and establishing well-documented liquidity risk management policies and procedures.

Through these enforcement cases, we see the SFC has become increasingly active in taking action against non-compliance with the FMCC (and other relevant rules and principles). Non-compliance may result in enforcement actions that will lead to financial penalties as well as reputational risks to fund managers. It is important for managers to adhere to the standards of conduct contained in various SFC codes, as compliance is crucial to demonstrate responsible stewardship of funds and protect investors.

Key Contacts

Ming Chiu Li

Partner | Financial Services

Email or call +852 2825 9752