Anti-Money Laundering Compliance Structure for VCC, Singapore

 The Variable Capital Company of Singapore (“VCC”) is an on-shore Singapore domiciled investment fund product set up under the eponymous Act. A VCC is required to comply with Anti-Money Laundering and Combating Financing of Terrorism (AML&CFT) regime of Singapore. The relevant regulatory provisions including the outsourcing structure to comply with AML&CFT requirements are provided in Monetary Authority of Singapore (the “MAS”) Notice VCC-01 dated 14 January 2021 (the “Notice”), the Guidelines to MAS Notice VCC-01 dated 4 December 2020 (the “Guidelines”) and Response to the Feedback Received for Proposed AML/CFT requirements for Variable Capital Companies dated 15 January 2020 issued by MAS (the “Feedback”) (all together the “VCC AML Regime”).

This post has been made specifically to bring out the differences between the regulatory provisions w.r.t AML&CFT for Cayman Islands domiciled funds vis-à-vis the VCCs. Since VCC is relatively new fund product, its outsourcing requirements are also generally thought to be the same as for Cayman Islands domiciled funds. However, the requirements to comply with the outsourcing of AML&CFT functions as per VCC AML Regime are unique and different from the similar obligations on Cayman Islands domiciled funds. Appreciation of such nuanced differences between Cayman Islands domiciled funds and Singapore domiciled VCC fund structure cannot be overemphasised to remain compliant with VCC AML Regime.

As per the Notice, though a VCC is allowed to outsource its AML&CFT function but it can do so only to an eligible financial institution (“EFI”). The list of EFIs is provided in Appendix 2 to the Notice and comprises institutions which are licensed or supervised by MAS. Generally, for a VCC the suitable EFI will be its fund manager which will be a holder of a capital markets services licence under the relevant regulatory provision of Singapore. It is pertinent to note that a VCC is not allowed to directly outsource its AML&CFT function to its fund administrator as part of the fund administration agreement which is the general practice for Cayman Islands domiciled funds.  

Further, it is mandatory for a VCC to execute a contract with its EFI to formalize the outsourcing arrangement for AML&CFT function. In addition, it is necessary that this contract must provide details of the AML&CFT policies and procedures that the EFI is expected to perform on the VCC’s behalf.  This contract can be a composite contract covering both fund management function and the AML&CFT function.  

This means that a VCC must have its own AML&CFT policy. A VCC cannot rely on the AML&CFT policy either of its fund manager or its fund administrator. It has been clarified by MAS in the Feedback that both the VCC and its fund manager must have separate and distinct AML&CFT policy though there can be similarities between the two. In case, a fund manager operates multiple VCCs, even then, each VCC must have its own separate AML&CFT policy.

The difference between the concept of ‘outsourcing’ and ‘reliance’ also distinguishes the VCC’s AML&CFT obligations from those of Cayman Islands domiciled funds. In case of reliance, an entity on whom reliance is placed would apply its own procedures to perform the function in question (and this is generally followed for Cayman Islands domiciled funds when a fund relies on the AML&CFT procedures of its fund administrator). In contrast, in case of outsourcing, the outsourced service provider would perform the function in accordance with the VCC’s AML&CFT policy as clearly highlighted in the Guidelines and the Feedback. However, there is no restriction for an EFI to further outsource a VCC’s AML&CFT function to the fund administrator by entering in a separate contract.

Due to the ubiquitous nature of Cayman Islands domiciled funds, the fund managers and their service providers are inclined to treat Cayman Islands’ AML&CFT process practices as global standard. But such an approach can have serious pitfalls specially when new on-shore investment fund products are on offer both in Singapore and Hong Kong. It is necessary to distinguish the regulatory provisions of each private fund product and accordingly define the business processes and contract requirements.

My experience in dealing with clients brought this into my sharp focus that both the fund managers and their advisors were not ready to accept the fact that VCC is mandated to outsource its AML&CFT function only to EFI and is required to comply with other provisions as highlighted above. Initially as part of our services and to ensure that our clients’ VCC remain compliant, we had to provide explanations and evidence to convince the fund managers and their advisors on the necessity to follow the approach as detailed above. Our efforts have started showing results and now fewer such questions get asked.  

Where There is a 'Will' There's a Contest

 It is a frequent question whether a Will is a robust tool to pass on the assets of the testator to the heirs.  Effectiveness of a Will, which comes into effect after the death of the testator, depends on testator’s situation. This note will analyse the factors that have an impact on the efficacy of a Will.

 A Will can be an effective succession planning tool when the testator very carefully chooses the time, the beneficiaries and asset to be distributed.  These critical issues if handled judiciously leaves no scope for ambiguity and thus ensures no need for another Will in the future. However, a Will’s effectiveness may be compromised when the testator makes multiple Wills at different points of time. Multiple Wills by a testator introduce an element of doubt about which Will, amongst many, is genuine and would take effect.  In such a situation, the possibility of challenge by a disgruntled heir is heightened because different Wills may have different beneficiaries, or same beneficiaries but with different inheritance provided in the Will. An heir who has either been left out or is disadvantaged gets sufficient incentive to challenge the Will on the grounds of genuineness, capacity, coercion, fraud etc. Any challenge introduces delay in the distribution of the assets and this may compel other heirs to agree on some compromise.

Further, a Will takes effect through a legal process leading to the issuance of a probate. Once a probate is issued by the court, it is not possible to challenge the Will and the assets are to devolve as per the probate. When the testator owns assets in a single jurisdiction (thus the probate process to be completed in a single jurisdiction) a Will again may prove to be useful.  However, when a person holds assets in multiple jurisdictions, in addition to take the probate in the primary residential jurisdiction of the testator, certain legal process (resealing of the probate) must be completed in each of the jurisdiction where the testator’s assets are situated. If the resealing is not done, then the distribution of assets situated in that jurisdiction can be challenged by any other heir left out from that asset.  The process of resealing can be lengthy as well as expensive as it depends on the law of each relevant jurisdiction where the assets are situated leading to delay in distribution of assets. So, the jurisdictional distribution of assets becomes a material factor in the effectiveness of a Will as a succession planning tool.

A Will can be used as a succession plan tool only for those assets which are held in the single name of the testator since as a legal owner he can pass on the assets as per his wish. In case, the assets are held in joint name with the right of survivorship, such an asset cannot be bequeathed by a Will. The reason is that such asset will anyway devolve on the surviving joint owner. 

When a testator desires to provide for the guardianship of a minor child after the demise of the testator, a Will can again be a good resource to safeguard the interests of the minor child.  The testator can ‘will’ a trusted person as the guardian to the minor child to ensure safe custody of the inheritance during the minority of the child and then to be bequeathed to the beneficiary on attaining adulthood. In case the testator does not appoint a guardian for the inheritance of the minor child, then court will get involved to appoint a guardian which may introduce uncertainties.

There are some situations when a Will is unlikely to be an effective succession plan. For example, when a testator has step-children from multiple marriages. In such circumstance, the possibility of dispute arising among the heirs is quite common and therefore likelihood of a challenge to the Will is high. This situation will be further exacerbated if the testator has made multiple Wills during his life time and / or holds assets in multiple jurisdictions. Further, a Will made when the testator suffers from severe illness might not serve the purpose. In such a situation, it becomes easy to challenge the validity of the Will on the basis of mental capacity (soundness of mind) of the testator and/ or coercion.   

As mentioned above, a Will requires certain legal process to be completed to get the probate and make it executable.  The issuance of a probate is a judicial process and, hence, open to public. This means that the contents of the Will will not remain private once the legal process is commenced. So, a Will is not suitable for those people who have an overriding objective to keep their succession plan private and do not want the heirs to go through the juridical process to get access to testator’s assets.

Investment Methods, Individual and Estate Planning

 Making financial investments by an individual requires careful consideration of the method used to make the investment. The method of investment is as important and critical as the selection of the investment itself. Though not much thought is given to the method of investment and all efforts go only towards the selection of the investment. A good investment selection can be rendered difficult to realise its benefits when the method of investment is not optimal.

The common methods of investment available to an individual investor (the “Investor”) are ‘in the name of the Investor’, ‘joint name of two or more Investors’, ‘a private investment company’ whose shares are held by the Investor (the “PIC”), a ‘trust’ whose settlor is the Investor and the beneficiaries the Investor and other persons.

To analyse which of the above method of investment is an optimal investment method, it is necessary to understand the expectation of an Investor either at the time of exit from the investment or to pass on the investment to heirs. In either case, the main factors would be to minimize capital gains tax, if any, (i.e. tax efficiency), immediate availability of the money realised from the sale of the investment; no or minimum cost to get back the money or the investment; and smooth transfer of the investment to heir in cases of the Investor’s demise.

Let us analyse the impact of each method of investment vis-à-vis main factors as a function of uncertainties of life.

If the Investor is alive at the time of exiting the investment except for the tax efficiency the other three factors may not be relevant. However, all the other main factors become relevant if the Investor is hit by uncertainties of life and is no more alive. In such a situation, neither the money will be immediately available nor will there be a smooth transfer of the investment to heir(s) till the inheritance process is completed which may take months to years. Further, the inheritance process itself may lead to substantial costs which may vary from 2% to 10% of the estate of the Investor depending on the domicile of the Investor and whether the investment holdings are multi-jurisdictional or not.

When the investment is held through a PIC and the Investor is alive at the time of exiting the investment the main factors may not be relevant including the tax efficiency since the PIC must have been set-up for tax efficiency. However, all the other main factors become relevant as in the case when investment is held in the name of the Investor if the Investor is subject to the uncertainties of life and is no more alive. Though at the first level i.e. the PIC there is no adverse impact since the investment continues to remain in the name of the PIC. However, the heir cannot be paid dividend by the PIC if the PIC exit the investment. The reason is that the shares of the PIC held in the name of the Investor are to be transmitted in the name of the heir(s). For the transmission to happen successfully the full succession related process has to be completed before the shares can be re-designated in the name of the heir(s). Consequently, there will be delay, cost and a succession process to be followed for the heir to get the money i.e. the similar adverse situation when the investment is held in the name of the Investor.

What is the situation when the investment is held through a trust? A trust is a contractual relationship with three distinct parties i.e. the settlor, the trustee and the beneficiaries. These three parties can be the same person or different persons. The critical difference for the trust is that the trust continues to remain in existence even if any of the three parties die and there is a predefined understanding to replace the trustee which ensures continuity of decision making for the trust. Assuming the Investor invests through a trust whose settlor is the Investor, trustee is a professional trustee company and the Investor is also a co-beneficiary with other persons (heir(s)). Let us analyse the impact on main factors if the Investor dies. On the death of the Investor, the investment will be continued to be held in the name of the trust. At the time of setting up the trust, the Investor would have chose a trust law and trust administration place to give it tax efficiency. Nothing changes on the demise of the Investor and the trust continues to have the tax efficiency. After the death of the Investor, if the trustee desires to sell a part of the investment and distribute it to the beneficiaries, the trustee can sell some investment and distribute the money to the beneficiaries within the normal timeline without incurring any additional costs. Finally, there is no need to follow any succession related process since the investment continues to remain in the name of the trust and the trustee will distribute the money to the beneficiaries as per the terms of the trust deed. Further, there is no adverse impact of having investments in multiple jurisdictions. In short, the trust method of investment is highly efficient on all the main factors.

The investment and its management through a trust is highly flexible and can be customised to meet specific needs and requirements of each Investor by use of revocable or irrevocable trust, discretionary or non-discretionary trust, having a provision for protector, having different categories of beneficiaries like primary and secondary etc. Certain trust structures can provide the added benefit of protection of the trust asset from creditors and bankruptcy proceedings which is not available for any other type of holding i.e. individual, joint holding or PIC.

How does the above methods of holding compare with the ownership in the joint name i.e. joint tenancy. The joint tenancy does eliminate some of the issues associated with ownership in individual name or through PIC but this also add some other complications. If all the joint owners die together then all the drawbacks associated with holding in an individual’s name will be encountered. Further, whenever the last joint holder of the investment dies, again all the drawbacks associated with holding in an individual’s name will resurface. The additional complication which is unique to this case is that the creditors of all the joint holders can make separate claims for whole of the investment. So, joint tenancy is at best a stop gap arrangement but not an effective solution.  

The above described scenarios are agnostic to the investment type i.e. financial assets or real estate or other valuables. Further, the uncertainty of life is not confined to the death but any situation which incapacitates the Investor’s decision-making abilities. The problem of delay and costs get exacerbated when the investments are held in multiple jurisdictions requiring separate succession process in each jurisdiction.

Unified Fund Exemption Regime, Hong Kong

The Unified Fund Exemption (the “UFE”) regime introduced by Inland Revenue (Profits Tax Exemption for Funds) (Amendment) Ordinance 2019 (the “Ordinance”) has provided far reaching profit tax exemptions to funds offered in Hong Kong irrespective of the fund’s domicile i.e. onshore or offshore. The previous profit tax exemption regime for funds i.e. Offshore Fund Exemption (the “OFE”) made distinction between onshore and offshore funds and the nature of investments.

The below note describes what has changed under UFE and how will it impact the fund industry.

·       QUALIFYING FUNDS: A fund that fulfils the below mentioned conditions can seek tax exemption:

o   All privately offered funds: UFE extends the tax exemption to all privately offered funds (whose definition is equivalent to collective investment scheme under Securities and Futures Ordinance) in Hong Kong regardless of their place of domicile (i.e. onshore or offshore) and legal structure. The definition of fund covers corporations or partnerships whether Hong Kong incorporated / set-up or outside. This is a substantial improvement over the previous tax regime where onshore privately offered funds operating in Hong Kong did not have the tax exemption.

o   Location of central management and control: The location from where the fund is centrally managed and controlled is not a relevant factor for seeking tax benefit under UFE. This means, even when the board meetings and investment decisions are made in Hong Kong the fund can claim tax exemption benefit. This is another change from the previous regime where the tax exemption was not available if the central management and control of the fund was in Hong Kong.

o   Number of investors, their contribution and distribution to sponsor: Only those funds qualify for the tax exemption which have at least 5 investors contributing 90% of the fund’s capital. Further, the distribution to the sponsor and its associates should be limited to 30% of the net proceeds arising from the transactions of the fund.

o   Special Purpose Entities (SPE): SPE owned wholly or partly by a fund for holding private equity investments only through private companies in Specified Securities (as defined in the Ordinance) and its derivates can also take advantage of the UFE to the extend owned by the fund. This means if a SPE’s 40% shares are owned by an eligible fund, then the SPE can also claim tax exemption up to 40% of the profit from transactions in Specified Securities.

·       QUALIFYING TRANSACTIONS: The profit tax exemption would be available when the fund undertakes the following types of transactions.

o   Definition of transaction: the definition of the transactions covers only buying and selling of assets (as defined in the Ordinance). Therefore, the profit tax exemption is available only from buying and selling of these assets.

o   Private Hong Kong company: Another change from the existing tax exemption regime is that investment in private Hong Kong company will qualify for the tax exemption provided the investment is held for no less than 2 years subject to limitation on the investment in immovable property as explained below under anti avoidance provisions.

o   Infrastructure immovable property: The limitation with respect to immovable property does not apply for investment in infrastructure immovable property either directly by the fund or through private company and therefore profit from such investment will qualify for tax exemption.

o   Incidental transaction: Transactions incidental to the qualifying transactions not exceeding 5% of the trading receipts both from the qualifying transaction and incidental transaction.

o   Intermediary: The transaction should be arranged or carried out in Hong Kong by a person licensed by or registered with Securities and Futures Commission (the SFC”).

·       Tainted issue: Under UFE, it is allowed to separate qualifying and non-qualifying transactions and claim tax exemption benefit only on the qualifying transactions. This is a significant change from the OFE regime which denied tax exemption for all the transactions of the fund in case there was any transaction which does not qualify for tax exemption.

ANTI-AVOIDANE PROVISIONS: Some substantial limitation which would deny the tax exemption benefit to fund are as follows.

·       Investment by fund manager and its staff: Investment in the fund by persons who have day-to-day control over the management of the assets of the fund will deny the fund tax exemption benefit. This means a fund manager /staff of the fund manager who also invests in the fund will not be allowed to claim tax exemption benefit for the fund. This is a major drawback because both for hedge and private equity funds it is common for the fund manager to also make investment in the fund. Such an investment by the fund manager is sometime a necessary pre-requisite to attract investors in the fund.

·       Non qualifying transactions:

o   Investment in debt security: As per the transaction definition, only profit derived from trading income is considered a transaction and not the profit derived from holding of the securities. The implication is that the debt funds and income from fixed income securities will not fall within the UFE regime and will therefore have to pay tax.

o   Investment in Hong Kong immovable property:  Investment income from Hong Kong immovable property held either directly or through private company is not tax exempt. However, this limitation of tax exemption for investment in immovable property is relaxed in case the private company holds no more than 10% of its assets in immovable property.

o   Special purpose entity: The exemption from profit tax for the income from investment held through SPE is available only till the time SPE remains a private company or the investment is in unlisted securities. As and when the SPE becomes a public company then the exemption is not available.

·       Excluded entities: business undertakings for general commercial or industrial purposes, group captive funds and employee funds are excluded from the definition of the fund and therefore cannot take advantage of UFE regime.

The benefits of the UFE regime for the fund industry are substantial though some major limitation factors like dis-allowance in case of investment by the fund manager, exclusion of investment in debt securities or debt fund and exclusion if the SPE or the underlying company’s shares are listed do impose substantial unresolved issues for the industry. At the same time, the new substance requirement for fund managers in off-shore jurisdictions like Cayman Islands, BVI and Bermuda may make it practically difficult for fund managers to create substance in off shore jurisdiction by holding investment related board meetings there. So, each fund operator should make a business call whether it is overall beneficial for them to unify and simplify their operations locally.

Create the CAUSE to bring the EFFECT

Theory of Karma is not only a guiding principle to live one’s life by. The theory which teaches to create right CAUSE to bring the desired result (EFFECT) can be applied to our professions too. All it requires is determination, perseverance and hope.

I experienced first-hand the actual proof of this theory of CAUSE AND EFFECT when my friend and I ventured on an unknown path to hike with full hope and determination that we would find our way.

My friend and I decided to hike the hills of North Lantau Island. The hills of Lantau are rugged and harsh and we are occasional hikers for fun.  On the public holiday of Dragon’s Boat Festival, all we wanted was a light hike to use the holiday and do some easy 4 to 5 km shaded walk on a sunny day. We chose Section 11 of Lantau Trail but landed up on the Olympic Trail around 3:00 p.m. After walking down some distance, as per the directions, we came at a point with two paths but no direction. One path was across the circumference of the hill and the other had steps going up. We decided to take the steps up. There were 11 sections of 52 steps each. These steps were along a concrete water drainage but we had no idea what to expect after reaching uphill. Once we climbed all the steps, we came across a sort of dead end, except a narrow pathway going up which appeared to be traversed once in a while and also gave an impression of a dried spring.

We decided to take that pathway. It was a steep climb full of stones, large and small. We could not find anyone going up or down. We had only one water bottle each and had no idea of the steep climb up and the amount of water we would need on the way. However, we kept going with some concerns like where will we reach, how far is the top, can we come down the same way (climbing down will be difficult due to steep slope), need to reach down before dark as it was already around 5:00 p.m. etc. As we continued to move ahead, the climb became increasingly difficult, and we were getting breathless easily, and had to ration our water due to limited supply.  

After some time, we came across a couple climbing down and this assured us that we were not taking a completely unknown path and also that it was possible to climb down. We talked to them to find out where would we reach if we keep on climbing up. Though they knew little English, we were encouraged from whatever little we could understand from them. The important aspect was we became hopeful and this created determination though the climb was very tough.

After a while, we met an Indian couple who were climbing down too.  They told us that they normally do this route. From them we came to know that the top was still about half an hour hike. This helped us to take a decision that we could continue to climb up without worrying about it becoming dark.  Again, our efforts (The CAUSE) created the EFFECT to have hope and determination. By now it was about 5:45 p.m. and we came across few more people who were climbing down. Still not sure when we would reach the top, we were very exhausted; water in our body and the bottle was depleting, and lots of doubts if it is prudent to go on.  

Then a miracle happened. We bumped into an Indian who was actually climbing up in our direction even at that hour, and not going downhill. Obviously, we started to talk to him and were extremely surprised to know that for the last 15 years, he does 35 KM hiking every weekend and this hike was a warm-up for the next morning 35 KM hike.  He very much appreciated our efforts to be on a very tough hike that many people find difficult to do even though he had seen few healthy elderlies on this trail too, which surprised us. He gave us tips to cover our heads, continue to sip water and not to put steps very hard. He agreed to guide us down through the other side of the hill (by slowing down his speed) and also offered to show us one more easy and good hike route once we reach down. He showed us a spring where we could refill our water bottles. Finally, with his direction we came down. We hiked about 15 KM and the 80% of this was climbing up and down.

The point here is that our efforts kept us giving hope and determination to complete the hike with support from the universe which came our way since we continued to move, create cause, and take help and support.

But why am I telling this story here? On a blog related with corporate compliance? Because in all spheres of our life it is we the individual who has to create the CAUSE to bring the EFFECT we want to see in our life. The same holds true for our professions too. For instance, in the compliance function we regularly come across situations with no apparent straight forward solution and such situations require a judgement call. How to make a judgement call in such situations? For this, it is necessary to dig and seek more and more information on the facts of the case and apply the regulatory provisions to these facts to appreciate the possible implications. This invariably leads to finding possible solutions which balances and minimize the risks for the stakeholders. That is, it is necessary to create the CAUSE to come up with an effective solution i.e. EFFECT. When proper and effective cause is not created, it leads to unsatisfactory and unconvincing solution, customer dis-satisfaction and weak audit trail i.e. undesirable effect.

Additional Responsibilities of ROOF Fund Managers under FMCC, SFC Hong Kong

The revised Fund Manager Code of Conduct (the “FMCC”) of Hong Kong has made a non-statutory distinction between those fund managers who are responsible for overall operations of a fund (the “ROOF”) and other fund managers. Hong Kong based fund managers are likely to fall in the ROOF category. In this note, the additional obligations imposed on fund managers who fall in ROOF category are highlighted.

1.     Disclosures: ROOF fund managers have substantial additional disclosure obligations as listed below towards the investors on various parameters related with the management of the fund.

a.     Leverage: To disclose to the investors the expected maximum level of leverage which a fund manager can employ on behalf of the fund and the basis of calculation of the leverage which should be reasonable and prudent.

b.     Securities lending: To disclose the fund’s policy on securities lending, repo and reverse repo transactions, and risk management policy. The fund manager is also required to disclose the details of such transactions to the investors. Both the disclosure shall be made at least once in a year.

c.     Liquidity management: To disclose the liquidity management policy, the liquidity risk of the fund, and explanation of any tools or exceptional measures which could affect redemption rights of investors.

d.     Termination: When a fund manger decides to terminate a fund, then the fund manager shall disclose to the investors all material information in relation to the termination of the fund in an appropriate and timely manner.

e.     Custody: The fund manager is also required to disclose to the investors the details of the custody arrangement for the assets of the fund, the material risks associated with the custody arrangement and update on any significant changes.

f.      Audit report: The fund manager shall provide the annual auditor report of the fund to the investor on request of the investor.

g.      Side pockets: The fund manager is obligated to provide full information about side pockets including the categorisation, policy and rationale for investment in side pockets to the investors. The information should cover side pockets limits; fee structure and charging mechanism; differentiation in the redemption lock-up period from the ordinary units; etc.

h.      Information on the fund manager: The fund manager shall also disclose adequate  information about itself including business address, relevant conditions and restrictions of its business, and the status and identity of the persons acting on its behalf.

i.       Information on the fund: The fund manager shall also disclose information on the fund that is necessary for the investors to make an informed judgement about their investment in the fund including any change of such information.

j.       Charges: The disclosure of the basis and amount of the fund manager’s fees, and charges shall be disclosed to the investors. When the fund manager is acting as principal then the mark-ups for such transactions and the circumstances under which transactions are done shall also be disclosed.

2.       Liquidity management

a.         The ROOF fund manager shall have appropriate and effective liquidity management policy to monitor the liquidity risk of the fund.

3.       Termination

a.       The decision of a ROOF fund manager to terminate a fund should take in account the best interest of the investors in the fund.

4.       Custody

a.       A ROOF fund manager shall select and arrange to appoint a functionally independent and properly qualified custodian for keeping the fund assets. Self-custody is allowed provided the custodial functions are independent from the person’s fulfilling fund’s management functions.

b.       A ROOF fund manager shall ensure continued suitability and financial standing of the custodian.

c.       A formal custody agreement shall be executed detailing various duties and responsibilities of the custodian.

5.       Appointment of auditor

a.       An independent auditor shall be appointed to audit the financial statements of the fund and at the minimum an annual auditor report shall be provided by the auditor.

6.       Fund portfolio valuation

a.       Details with respect to the valuation requirement have been discussed in one of the previous note on the subject.  

7.       NAV calculation and pricing

a.       To ensure that the NAV calculation is done in accordance with the constitutive documents of the fund and the valuation policies and procedures thereof.

b.      The policies should be designed to detect any pricing errors and to compensate the investors for any material pricing errors.

8.       List of Policies and Procedures

a.       A ROOF fund manager shall maintain a list of policies and procedures for its fund management functions.

Overall, the FMCC puts obligations on a ROOF fund manager to maintain relevant policies, to disclose policies and other information about the operations of the fund to the investors and to ensure that the fund’s business is carried out in compliance with the relevant policies. Any operational deviation from the policies of the ROOF fund manager is likely to be viewed seriously by SFC.

Fund Manager Code of Conduct, Hong Kong and Valuation of fund assets

Managers of collective investment schemes and of discretionary accounts have to implement provisions related with valuation of fund assets as provided in the revised Fund Manager Code of Conduct (the “FMCC”) w.e.f. 17 November 2018 as part of their compliance journey and to monitor its compliance. In this regard, the step by step action to be taken by managers to keep themselves in compliance with the applicable provisions of FMCC are discussed below.

1.       Maintain and implement valuation policies, procedures and processes (the “Valuation Policy”)

a.       Mandatory to maintain a documented Valuation Policy

b.       The Valuation Policy should also cover the exception circumstances when price override or deviation can be done

c.       To ensure proper and independent valuation of the fund assets are performed

d.       The valuation is consistently applied to similar type of fund assets as per the Valuation Policy

2.       Considerations for drafting the Valuation Policy:

a.       The Valuation Policy has to be consistent with the requirement of section 5.3.1 to 5.3.7 of the FMCC

b.       Applicable accepted accounting principles as well as best industry standards and practices for valuing fund assets and follow the general principles as laid out in section 5.3.6 of the FMCC unless otherwise specified in the constitutive documents of the fund

c.       Ensure that the fund’s documentation on valuation is consistent with the Valuation Policy

3.       Periodicity of valuation must be appropriate for the fund assets and be aligned with the dealing frequency and timelines.

4.       Disclose the frequency of valuation and dealing and basis valuation to the investors in the fund.

5.       Independent review of Valuation Policy

a.       The Valuation Policy has to be reviewed by a functionally independent third party. Independent director and internal audit can be considered to be functionally independent third party

b.       The review must be done periodically but at least annually

c.       The first independent review must be completed before the anniversary of the implementation of FMCC

d.       Effectiveness and consistent application of the valuation policy over a period of time. The review shall specifically focus whether valuation policy appropriately value the assets of the fund as a function of the complexity of the assets held by the fund. This is a very critical area of focus and is also likely to invite the attention of the regulator.

6.       Outsourcing the valuation services to third parties, the manager has to ensure the suitability of the service provider, adherence to the manager’s valuation policy and manager continues to remain responsible for the valuation of the fund’s assets.