On 9 October 2024, the Securities and Futures Commission (SFC) issued a circular (the Circular) stating its intention to place greater emphasis on the supervision of asset management firms and reminding personnel of their regulatory obligations, after it identified various deficiencies and substandard conduct in respect of the management of private funds and discretionary accounts which had resulted in substantial losses for investors.

The regulatory breaches noted in the Circular are wide-ranging, including failure to identify, document, manage and disclose – as appropriate – market, concentration, credit and liquidity risks. An appendix to the Circular has been published on a no-names basis highlighting examples of inadequate conduct in the handling of conflicts of interest, risk management, disclosure to investors and use of valuation methodologies. Examples highlighted include managers that have:

  • Used fund assets to provide loans to affiliates on terms much more favourable than available in the market generally;
  • Retrospectively allocated trades with unrealised profits in favour of connected parties;
  • Acted contrary to their stated investment objective by making a singular investment while also acting as financial advisor to, and receiving an undisclosed monetary benefit from, the issuer of the notes purchased;
  • Delayed redemption payments to certain investors due to liquidity concerns while giving priority to staff whose redemptions were settled in full first;
  • Continued to invest in illiquid stocks and notes notwithstanding a significant amount of overdue redemption payables;
  • Provided unsecured loans having made no assessment of the financial position of the borrower, and renewed the loans notwithstanding late interest payments;
  • Relied on outdated credit rating reports while failing to consider negative news about an issuer’s financial position when investing a significant proportion of the fund’s assets into further notes;
  • Failed to disclose significant exposures and subsequent defaults to investors with substantial adverse impacts on the fund’s net asset value (NAV) and its ability to meet its liquidity needs; and
  • Failed to take reasonable steps to obtain from guarantors the difference between a bond’s par value and its market value, while continuing to book the full value of the receivables in the NAV computation.

The number of SFC investigations into intermediary misconduct generally has been increasing steadily in recent quarters and, in light of the findings published in the Circular, the SFC has indicated that it will give “high priority” to combatting misconduct in the asset management industry over the “coming year”. This will involve “step[ping] up its disciplinary actions and impos[ing] harsher penalties against similar or persistent misconduct”. We therefore expect that the SFC will use the range of levers available to it to assess firms’ compliance (including offsite monitoring and on-site inspections) and will take enforcement action against both firms and individuals (including fines, reprimands and seeking disqualification orders) as appropriate.

While the SFC does not mention how many individual asset management firms were involved in the examples it cites, it appears to be concerned about practices in the industry as a whole. The SFC says the breaches noted are “egregious” and suggest a lack of integrity on the part of the personnel involved. It noted that the breaches undermine the integrity of the market and damage investor confidence in Hong Kong as an international asset management centre, and that it is therefore ready to take “decisive action” to send a “strong deterrent message”.

Directors and senior managers of firms have been put on notice to “critically review the areas of concern” and “give priority to strengthening their supervisory and compliance programmes”. They are advised to have an independent and objective audit conducted on their firms’ compliance. Firms may therefore wish to take the opportunity now to assess not only the robustness of the policies and procedures in place but the extent of compliance by staff, both with the spirit of the Overarching Principles and the letter of the Fund Manager Code of Conduct (the fifth edition of which was published this month), the Code of Conduct for Persons Licensed by or Registered with the SFC and the related Internal Control Guidelines as applicable.

Norton Rose Fulbright can assist asset managers to assess compliance with their obligations, strengthen policies and controls, and – if necessary – mitigate and self-report breaches that may be identified, which the SFC is likely to view favourably when determining any disciplinary action.