New rules seen to impact private fund launches in HK

The Securities and Futures Commission’s  (SFC) amendments to the fund manager code of conduct (FMCC) is set to overhaul the way the private funds industry operates in Hong Kong later this year, according to legal and industry experts.

The overhaul of the code should offer greater disclosure requirements, to the benefit of end investors. But it is likely to raise the costs for private fund managers in particular to remain compliant with the stricter rules.

The new FMCC regime will come into effect on November 17 this year. The code of conduct will require specific disclosures to be made to investors on areas ranging from risk management and liquidity management to leverage employed and securities lending. This means that firms have to ensure there are policies in place to meet these disclosure demands, raising the compliance costs for smaller fund managers.

“[When] implementing a regulation like the FMCC, firms will have to spend more management time in terms of compliance and possibly even money to adhere to the new requirements. It definitely increases the regulatory burden,” Philippa Allen, CEO of Compliance Asia Consulting (CAC), told AsianInvestor.

“It is a huge change for the funds industry, which will require changes in prospectuses, legal agreements, internal policies and procedures. People will need time to do that,” she added.

Extra costs could include the need for aspiring fund managers to hire external consultants to offer advise, which could be a costly endeavour. 

The changes to the FMCC come as part of the broader set of proposals to enhance asset management regulation and point-of-sale transparency, the consultation conclusions of which were announced on November 14, 2017.

Investor benefits 

The FMCC has been around since 1997, but it has to date confined itself to general guidance. There are also currently no structural or prescribed disclosure requirements for private funds, which will be a key focus of the updated code.

The motivation for the FMCC amendments comes from the global regulatory shift towards transparency in financial markets, according to most experts.

As a July 2017 note by Coventus Law suggests, the SFC is attempting to ensure its regulation complies with broader international initiatives such as those of the International Organisation of Securities Commissions (IOSCO).

Rolfe Hayden, partner at legal firm Simmons and Simmons, said the new rules should not change how investments are made.  

“But there will be greater disclosures by fund managers and funds, and to the extent the relevant documentation is read and understood, the new requirements should be beneficial to them,” he told AsianInvestor.

But the tighter regulatory norms could have an impact on asset managers seeking to establish private funds. They could decide to launch new funds from lighter touch financial jurisdictions such as Singapore, noted CAC’s Allen.

The sentiment was echoed by Hayden. He noted that outside the European Union, private fund managers often enjoy very limited regulation, so Hong Kong’s new rules make it a relatively more onerous place for private fund registration.

“Some may say this disadvantages Hong Kong’s private fund industry,” he noted, adding: “While it is unlikely to push existing fund managers to relocate—that is a big cost and exercise—it may mean a hedge fund start-up for instance, looks at Singapore as an alternative.”

Regulatory clampdown

Private funds—and discretionary accounts—have been on the SFC’s scanner for the past 24 months. Private funds are sold to or invested in by professional investors and not offered on a retail basis. These can include hedge funds, private equity and venture capital funds.

In recent years, there has also been a raft Chinese asset managers setting up shop in Hong Kong – many of which are unaccustomed to policies that are increasingly becoming the global norm, according to Michael Wong, partner at legal firm Dechert.

As of early January there were 323 private equity funds with a Hong Kong-based general partner and 204 active PE firms. In addition, 105 venture capital funds with Hong Kong-based GPs and 116 active venture capital firms were based in Hong Kong, said data provider Preqin.

On September 15 last year, the markets regulator issued a circular on the common instances of poor compliance by firms managing private funds and discretionary accounts.

These included a failure to ensure suitability of funds for clients, inadequate systems to protect client assets and failure to have appropriate liquidity management policies in place.

“The regulators want to ensure there are adequate policies in place for fund managers to manage different operating scenarios, and they know what they are doing when they manage third-party money,” Wong told AsianInvestor.

Hayden pointed out that the disclosures under the FMCC are only applicable to the extent the fund manager is based in Hong Kong and is responsible for the operation of the fund.

For instance, a retail fund that is registered outside Hong Kong but operated by a Hong Kong-based fund manager would fall under the auspices of the FMCC, Hayden said. But in practice it is unlikely that funds that are registered outside of Hong Kong and not authorised by the SFC would fall under the regulator's microscope.

“In reality, Hong Kong fund managers are not often responsible for the operation of mutual funds that are registered outside Hong Kong and not SFC-authorised,” he added.

While private fund managers may be affected, the new code of conduct is unlikely to pose a problem for larger international fund houses.

“Although all compliance is a burden, the standards are likely met already,” Simmons and Simmons' Hayden noted.

Rakesh Vengayil, deputy CEO for Asia Pacific at BNP Paribas Asset Management endorsed that position. He told AsianInvestor that he believes the proposals will further strengthen Hong Kong’s position as a leading asset management centre and are broadly in line with regulations in comparable international markets in which they operate.