HK SFC issues “sweeping” circular on private funds

The regulator could create unnecessary work for private equity firms by adopting a new approach, says Philippa Allen, CEO of ComplianceAsia.
HK SFC issues “sweeping” circular on private funds

Hong Kong’s securities watchdog yesterday yesterday issued a circular expressing concerns about conflicts of interest within some private funds and discretionary accounts. But the regulator's approach could create unnecessary work for many asset managers, argued Philippa Allen, chief executive of consultancy ComplianceAsia.

“The SFC [Securities and Futures Commission] is making a sweeping general statement and a lot of legitimate private equity managers will have to scramble to show they comply,” she told AsianInvestor.

The SFC said yesterday that it had found that some private funds and discretionary accounts “with concentrated, illiquid and interconnected investments” had “irregular features”.

The watchdog’s concerns largely relate to hybrid funds that contain both liquid and illiquid assets, and the potential for stock market manipulation via transfer of information within the asset manager.

Common practice

However, Allen noted, some of the irregularities the watchdog has highlighted are standard activites in the private equity industry and in themselves not necessarily bad practice.

For instance, it is relatively common for a principal of an asset manager to also be a director of a smaller listed company in which the asset manager is invested, she said. Such directors have a valuable role to play in providing their knowledge and expertise to the portfolio company.

It is possible that some firms are conducting abusive practices, Allen conceded: without the necessary Chinese walls and controls in place, such arrangements could lead to conflicts of interest.

But the regulator already has fraud provisions it could use to deal with such issues, rather than making a “sweeping” move such as this, she argued. “The SFC has discovered a few abuses, but has rolled out a circular that everyone has to do something about, even though the way they operate is perfectly valid."

One reason for this increased scrutiny may be the rise in the number of private equity managers and Chinese private fund houses obtaining licences to operate in Hong Kong, said Allen. The smaller mainland players, for instance, do not yet operate to international standards, she noted.


The “irregularities” cited by the SFC in the circular include that discretionary account holders held sizeable concentrated stock positions in their accounts and asset managers acted solely at the direction of their clients without exercising investment discretion.

The SFC also identified instances where fund investors or discretionary account holders were substantial shareholders, directors or affiliates of the listed companies invested by the funds or the discretionary accounts. In one case, it said, a director of an asset manager was also a director or chief executive of listed companies in which funds under the management of the asset manager were invested.

“The nature and commercial substance of the practices highlighted are questionable and may conceal shareholdings in listed companies,” said the SFC. It also warned that undue concentration of illiquid or interconnected stocks may have an adverse effect on the ability to meet investors’ redemption requests.

New scrutiny

These are not new developments as such, said a senior investment funds lawyer based in Hong Kong. “Such issues have existed for quite a while in Asia; they simply haven’t been focused on.”

Hybrid funds that incorporate both liquid and illiquid pools of assets came into vogue in the region around 2006, she told AsianInvestor. “They’ve not been widely understood in Asia and, as a result, many of the conflicts of interest that arise from them are not well understood.”

However, the lawyer said: “The industry should expect this to be a significant point of focus in future audits.”

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