Sunday, June 23, 2019

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.

Sunday, June 9, 2019

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.