On 6 September 2019 the Securities and Futures Commission (SFC) enhanced its Frequently Asked Questions on the Implementation and Transition Arrangements of the Code on Unit Trusts and Mutual Funds (FAQs). Question 13 of the FAQs has been updated and Questions 14 to 18 have been added to deal with questions on the requirements applicable to investment by funds in loss-absorption products (LAPs). The requirements apply only to SFC authorised funds. These FAQs follow extensive discussions with the industry regarding the treatment of LAPs and the transitional arrangements for funds which already invest in such products.
FAQ 13 confirms that not all LAPs have to be taken into account in calculating net derivative exposure (NDE). Managers must exercise their own judgement in assessing whether a particular LAP involves an embedded derivative.
FAQ 14 addresses the disclosure requirements for funds which may invest in LAPs, including the types of LAPs to be invested in, the fund’s expected maximum exposure and the risks associated with such investments. If a fund may invest 30% or more in LAPs, the associated risks should be highlighted in the key risk section of the Key Facts Statement. Funds intending to invest more than 50% in LAPs will be reviewed by the SFC on a case by case basis, taking into account, inter alia, the fund’s design, target investors, the managers’ experience and risk management systems and international regulatory standards for public funds.
FAQ 15 helps to clarify the types of debt instruments which are categorised as LAPs.
FAQ 16 provides that existing funds have until 1 January 2020 to comply with the requirements. Most managers will already be in the process of updating their funds’ offering documents for the revised Code on Unit Trusts and Mutual Funds which became effective on 1 January 2019. The disclosure requirements for LAPs set out in the revised FAQs should be incorporated into that updating process.
FAQ 18 requires the manager to assess whether the changes to the offering documents to comply with the disclosure requirements for LAPs constitutes a material change, in which case prior approval from the SFC will be required. The FAQ also refers to the obligation to notify investors.