SFC Reminds Fund Industry Participants and Intermediaries of their Obligations to Clients

In light of the market volatility caused by the global outbreak of COVID-19, the Securities and Futures Commission (SFC) published two circulars on 27 March 2020 reminding fund industry participants and other intermediaries respectively of their obligations to take care of the interests of their clients.

Circular to management companies and trustees and custodians of SFC-authorized funds

The first circular¹, directed at fund managers, trustees, and custodians of SFC-authorized funds, notes that in light of current market conditions, the SFC has stepped up its monitoring of SFC-authorized funds and expects managers to cooperate with the SFC on the heightened reporting requirements. The circular also reminds the fund managers of their existing obligations in relation to management of fund liquidity and fair treatment of clients, including:

1. Closely monitoring the dealing and trading of the funds under their management and in the case of Exchange Traded Funds (ETF), assess whether the continuous trading of the ETFs under their management is able to be conducted in a fair and orderly manner and in the best interests of investors;
2. Keeping investors informed at all times and immediately reporting to the SFC any untoward circumstances relating to the funds under their management, including, without limitation, the use of liquidity risk management tools such as any intention to increase or apply any swing factor (or anti-dilution levy) exceeding the one that is disclosed in the offering documents and any decision to defer redemption, suspend creation and/or redemption in the primary market and/or the secondary market trading and potential impact on the fund. Fund managers should consult the relevant trustee or custodian before using liquidity risk management tools;
3. Ensuring that all assets of the funds are fairly and accurately valued in good faith and in the best interests of investors and in accordance with the constitutive and offering documents as well as applicable laws and regulations;
4. Considering the need for any fair value adjustments (particularly in respect of less liquid or suspended securities such as high yield bonds or fixed income instruments and suspended stocks) and constantly reviewing the fair value adjustment policies and procedures to ensure their continued appropriateness and effective implementation in light of the rapidly changing market conditions.  The process and conduct of fair value adjustments (including any decision to use or not to use fair value price) should be done by the fund managers with due care, skill and diligence and in good faith, in consultation with the trustee or custodian of the funds;  
5. Exercising due care, skill and diligence in managing liquidity of funds, in particular, ensuring that actions taken in meeting redemption obligations should not have any material adverse impact on the fund and its remaining investors. For example, trying to meet a fund’s redemption requests primarily by using the fund’s cash or by selling the fund’s most liquid assets may have an adverse impact; and
6. Using appropriate liquidity risk management tools (such as swing pricing or anti-dilution levy) to properly allocate the costs of redemption (such as transaction costs for liquidation of assets) to the redeeming investors, and to ensure fair treatment to investors who remain in the funds.

As for trustees and custodians, the SFC reminds them of their duties to safeguard fund assets and provide independent oversight of the management of funds, for example, on valuation of the funds and use of liquidity risk management tools.

The SFC also emphasises the need for all parties to give the SFC early alert of any material issues affecting their funds, in particular

• Any intention to increase or apply any swing factor (or anti-dilution levy) exceeding what is disclosed in the offering documents;
• Any serious contemplation of suspension of dealings; and
• Any significant decrease in the value of the fund (e.g. a drop of 10% or more in a fund’s net asset value in a single day).

If in doubt, managers, trustees, and/or custodians should consult the SFC.

Circular to Intermediaries – Reminder of Important Obligations to Ensure Suitability and Timely Dissemination of Information to Clients

The second circular², directed at licensed and registered persons, reminds them of their obligations under the Code of Conduct for Persons Licensed by or Registered with the SFC (Code of Conduct) when distributing investment products to clients, in particular:

• The suitability obligations when making solicitations or recommendations; and
• The obligation to disseminate information in a timely manner when they hold an investment product directly or indirectly on behalf of their clients.

In the wake of the COVID-19 outbreak and given the potential impact on market volatility and liquidity, as well as credit quality, licensed and registered persons must act in the best interests of their clients, and should take extra care in their solicitations or recommendations and management of investment portfolios. The SFC reminds licensed and registered persons to:

1. ensure that due diligence is conducted on investment products on the current approved product lists on a continuous basis at appropriate intervals, having regard to the nature, features and risks of the investment products, including any deterioration in credit quality or liquidity, market and industry risks related to the COVID-19 outbreak and other factors which may have an impact on the risk return profiles and growth prospects of the investments;
2. Give due consideration to all relevant circumstances specific to a client when assessing the suitability of an investment product for the client, including the client’s current financial situation, investment objectives, risk tolerance, investment horizon and liquidity needs, as well as the risk profile and concentration risk of the existing investment portfolio;
3. Explain to the client the risks and features of the investment product, including its credit quality, liquidity, termination conditions and transaction costs; and
4. When recommending an investment product to a client, present balanced views at all times, do not focus solely on advantageous terms such as high coupon rates or yields and explain the disadvantages and downside risks, such as credit deterioration and illiquidity.

Where licensed or registered persons hold investment products on behalf of clients, the SFC reminds them to disseminate to clients notices and other communications prepared or issued by the investment product issuers, product arrangers, or management companies on a timely basis upon receipt. Such notices and communications may contain material information which may be crucial to the clients in making investment decisions, such as untoward circumstances relating to a fund which may include use of liquidity risk management tools by fund managers.