Behavox Blog

Hong Kong experiences rising tide of executive accountability

Feb 19, 2018 9:40:44 AM / by Behavox Regulatory Intelligence



Hong Kong’s asset managers face heightened scrutiny later this year when the new Fund Manager Code of Conduct (FMCC) comes into force, and while the new rules are a necessary step in enhancing the region’s market integrity, the task ahead could be arduous for some.


The Securities and Futures Commission of Hong Kong took submissions from top players in the fund management industry to tackle issues in securities lending and repurchase agreements, custody of fund assets, liquidity risk management, and disclosure of leverage by fund managers.


Derek McGibney, managing director of management consultants Cordium in Asia said: “The task ahead is not as simple as most think.”


Conflicts of interest in the sale of investment products are also covered as a key area of focus, and also aim to address shadow banking risks in the funds industry, as well as associated threats to the financial stability of the market.


Key issues concerned (amongst other things) fraud, misleading financial statements and serious conflicts of interest. We expect that the SFC will continue to use all statutory powers available to it to hold listed corporations and their directors and senior executives accountable for their actions.


The backdrop is a renewed focus on corporate fraud and misfeasance which are now top enforcement priorities for the SFC and will likely continue to be through 2018.


Two permanent specialised teams were set up under the SFC’s Enforcement Division in late 2016, and as of October 2017, there were around 136 active corporate fraud and misfeasance investigations, 28 of which were particularly serious in the SFC's view.


The numbers more than doubled the total from the previous year, and show how seriously Hong Kong is taking its duties to create a culture of accountability and raise standards amongst senior managers.


SFC-watchers will note the enhancements are intended to reflect the latest international benchmarks concerning the conduct of fund managers issued by global regulators, such as the International Organization of Securities Commissions (IOSCO) and the Financial Stability Board (FSB).


“Existing fund managers and discretionary account managers (i.e., regulated persons under Type 9 regulated activity) should carefully consider the wide-ranging amendments to the FMCC and the Code of Conduct,” said Michael Wong, partner in the Hong Kong office of law firm Dechert, “as a substantial amount of work and time may be needed to update policies and procedures to comply with these amendments.”


Given the scale at which its market is growing, and its reputation for weak enforcement, Hong Kong is attempting to foster a more robust regulatory regime that is in line with international regulatory developments.


“The new requirements are aligned with global and international standards, and also demonstrate the shift towards greater transparency in financial markets, particularly in relation to fees and conflicts of interest,” said William Hallatt, head of financial services regulatory in the Hong Kong office of Herbert Smith Freehills law firm.


Asset managers will need to carefully consider the impact of the new code on their business models, particularly as certain requirements only apply to those fund managers that are “responsible for the overall operation of a fund”, Hallatt said.


“Once this analysis has been completed, firms should then start preparing to make the necessary changes to their documentation (internal and client-facing), as well as systems and controls,” he said, “as a number of the amendments are in line with regulations in the United Kingdom and the European Union, firms should also ensure that a harmonised approach is adopted.”


Experts say early planning and scheduling of implementation steps will be key.


The code requires managers to establish a dedicated risk function, and although proportionality will be applied, experts say that, barring an actual crisis, there is no clear way to measure effectiveness.

“Identify, measure and monitor risks, this is a good process, and is one the SFC is taking from other jurisdictions,” said Michael Langton, executive at Linedata QRMO, an outsourcing and risk management company in a recent FMCC webinar. “Once we have identified and measured, the next step is to monitor and manage risk.”


When there is a breach, firms need to be able to manage, and show that they have managed any issue, Langton said. “The FMCC wants to ensure there is a clear, transparent and identifiable way of escalating risk management issues throughout the organization, particularly to the C-suite and the board of directors.”


It will depend on the size of the fund, but the creation of a risk committee is advisable, lawyers said.


“You must not just show the SFC you have these policies in a nice shiny book, you have to live it,” said Langton. “Keep detailed records of any breaches that may occur, why you have identified certain risks for example, and also keeping minutes so if any changes occur you have a record, a historical audit trail of this for the SFC.”


The view from the UK and the US is similar, and Hong Kong funds will quickly realise if something hasn't been documented, from a regulatory perspective, it does not exist.


“So when the tide goes out and a crisis occurs, if you don't have the documentation to demonstrate it has taken place you are in a difficult place when trying to explain it to the regulator,” said Langton.


Firms of all sizes will have to work out how they will address these concerns, and for McGibney this constant feedback loop of “monitor, manage, review” is the new everyday compliance need.


“Change in regulation is the norm now, every year there are new regulations for people to deal with, not just Hong Kong but from everywhere in the world,” he said.


Risk management today is more complicated than mere rule interpretation; as risk evolves, so does the process for managing it, solutions need to be by-design and pragmatic.


“Circumstances change, and it’s always good to reassess your controls against the environment,” said McGibney.


The proposed changes, concerning the FMCC and the Code of Conduct for Persons Licensed by or Registered with the Securities and Futures Commission (Code of Conduct), enter force in November 2018.


The amendments to the Code of Conduct become effective in August 2018, with the fully revised FMCC kicking in three months later.


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Disclaimer: This content is intended to provide general information in summary form on legal and regulatory topics, current at the time of publication. It does not constitute legal advice and should not be relied upon as such.

Topics: senior managers regime, compliance, hong kong