As the Asian fund management industry continues to grow and Hong Kong is well positioned to support private fund managers investing in China, the Hong Kong Securities and Futures Commission (SFC) published guidance on the licensing obligations of private equity firms conducting business in Hong Kong on 7 January 2020. In addition, the SFC also amended the Fund Managers Code of Conduct on 14 November 2018, enhancing the applicable SFC’s expected standards of professional conduct. Discretionary fund managers in Hong Kong. Given the heightened regulatory scrutiny on private fund managers, private fund industry players have critically re-evaluated their business models, and some fund managers have shifted gears to become licensed investment advisers in Hong Kong to advise fund managers on operating and managing funds from outside Hong Kong. .
Affirmed by the Securities and Futures Appellate Tribunal (adviceThe SFC decision in Cardinalsea Consulting Ltd v (CCL), the Hong Kong-licensed investment adviser for five private funds, and its responsible officer (collectively “of applicants“) reminds the fund industry that the SFC takes its supervisory role seriously. Investment advisers (not just fund managers) are required to act independently and with reasonable skill, care and diligence in the best interests of fund investors when using their financial knowledge and acting in a delegated capacity. The paramount importance of protecting the interests of investors extends beyond the investment adviser’s delegated competence, and the SFC holds that the investment adviser has an obligation to concern itself with the fund manager’s investment decisions (ie, in the case of CCL, entry into the inter.-Fund Loans among the five private funds). ) if such decision is not made in the best interest of the Fund and/or its investors.
Although CCL was appointed by the fund’s non-HK-regulated fund manager to act as lead investment adviser responsible for providing investment advisory services in relation to each fund (incorporated in the Cayman Islands), SFAT’s findings provide insight as to the SFC. A regulatory stance on the standard of conduct expected of licensed investment advisers is delegated broad powers to:
1. Extent of delegated powers
An investment adviser’s obligations arise from the terms of its investment adviser agreement (IAA) entered into between the Adviser, Manager and/or Fund. Since the IAA does not mandate an investment adviser to remain passive and act only until required by the manager or the fund, the clear intention will be to the contrary, that it is the investment adviser’s responsibility to provide timely, effective and professional advice. way The investment advisor, being a professional and experienced party, should be aware of the market movements and provide effective and professional advice in time for the best interest of each fund.
2. Advising on entry of loan
Private funds were entered into only for the purpose of addressing the liquidity needs of borrowing funds. Specifically, the loan terms had the following features:
a The loans were not backed by any collateral or guarantee and provided limited protection to the borrowing funds in the event of default or late repayment;
b One of the loans was interest-free, and the interest rate on some loans fell far below the margin loans offered by the execution brokers. and
c One lending fund did not have sufficient liquidity at the time of lending and another had immediate liquidity problems after lending.
The investment adviser and in particular its responsible officer, who is described as an experienced industry participant, is expected to have knowledge of the basic and reasonable safeguards associated with the loan arrangement, for example, collateral protection or security, and regular payment provisions. Failure on behalf of Borrowing Funds to advise of the need for such terms and conditions/safeguards constitutes a flagrant disregard of the Investment Adviser’s fiduciary obligations vis-à-vis Borrowing Funds and their investors.
3. Violations of General Principle 9 of the SFC Code of Conduct and the importance of maintaining adequate documentary evidence
Licensees (both corporations and persons accredited therein) are expected to comply with the SFC’s published guidance, including the Code of Conduct for Persons Licensed or Registered by the Securities and Futures Commission.code) while conducting regulated activities. The SFC will be guided by the requirements of the Code, including general principles, in assessing whether licensees are “fit and proper” to remain licensed. In particular, the SFC considers that it is fundamental for senior management (ie, responsible officers) to bear primary responsibility for the maintenance of standards of reasonable conduct and compliance with proper procedures by licensed corporations. Although the Code does not have the force of law and does not override any statutory provision, it is recommended that licensees still act in a manner that meets the requirements of the Code.
Failure of investment advisers to maintain documentary evidence (electronically or physically), recording the rationale for advice given and seeking to demonstrate compliance with the SFC when considering fairness considerations for each fund/its investors, risks diminishing the level of fairness and puts the investment adviser at a disadvantage. SFAT criticized the lack of contemporaneous documentary material to support the case for the applicants. The SFC argued, which the SFAT accepted, that the lack of supporting documentary evidence should raise doubts as to whether the applicants had properly conducted any comprehensive and balanced assessment of the internal credit arrangements and submitted those assessments to the fund managers for consideration.
Independent investment advisers have an independent obligation to protect the legitimate interests of investors when they give advice, regardless of the fact that their advisory engagement and mandate flow from an IAA entered into with the manager and/or fund. SFAT clarified that this obligation should be maintained even if “In giving advice, that advice is contrary to the intended wishes, or decisions actually made, of those higher up in the delegated chain of management.It is therefore important for investment advisers to consider the relative positions of all relevant stakeholders and to exercise their duties with care and integrity to avoid contravening the requirements of the Code.
The confirmation of SFAT reinforces the fundamental principles of the SFC’s regulatory approach that the requirements of the Code serve as a benchmark for the conduct of intermediaries when dealing with investors. As a licensed person, the SFC’s expectation of an intermediary’s standard of conduct goes beyond mere contractual obligations. It is hoped that the arbitrator will fully play his part in facilitating and achieving the SFC’s statutory objective of providing protection to the investing public.
A private fund’s investment adviser should (i) critically evaluate the terms of its IAA to ensure that there is mutual understanding between itself and the delegated manager regarding its roles and responsibilities; and (ii) review its compliance program to ensure that its internal policies and procedures are sufficiently robust and are implemented and enforced by senior management personnel. Furthermore, funds investing in debt are expected to critically review the debt arrangements to ensure that they have reasonable safeguards in place to provide basic protection to the fund’s investors.
Finally, SFAT, as the review body considering the SFC’s regulatory decision on appeal, has the power to make a range of orders under the Securities and Futures Ordinance, which can extend any suspension order against arbitration proposed by the SFC. In this appeal case, SFAT held that extension of the suspension order against the responsible officer of CCL by seven to nine months was warranted. SFAT imposing a longer suspension period warns the asset management community at large that the regulator will not shy away from using its enforcement powers to police undesirable behavior at senior management level. More severe penalties can be imposed to deter misconduct, and responsible officials will be held personally accountable for their regulatory violations. Similarly, it trickles down to representatives of fund managers responsible for providing investment advisory services.
Investment advisers are reminded to ensure that their responsible officers are fully trained and aware of their obligations and duties in overseeing the provision of investment advisory services. This includes their supervisory role in assessing the basis and execution terms of any proposed trades to ensure they are in the best interests of the Fund and investors. If there is any doubt in this regard, the case should be forwarded to the manager accordingly. It is also imperative to maintain proper records and documentation of such steps so that the investment adviser is well positioned to demonstrate its compliance to the regulator if required.