40 Things You Should Know to Pass HKSI Paper 6 – Regulation of Asset Management

TOPIC 1 – GENERAL REGULATORY FRAMEWORK

1. Key SFO Definitions

Asset management

Defined as: providing the service of either “real estate investment scheme management” or “securities or futures contracts management”.

REITS are covered in Topic 3.  Securities or futures contracts management is defined as: “managing a portfolio of securities or futures contracts for another person by a person other than certain excluded persons”.

Specifically excluded from the above definition are:

• Corporations which only carry on business for wholly owned subsidiaries or fellow subsidiaries and their holding companies
• Persons licensed for Type 1 and/or 2 activities (dealing in securities and/or futures contracts) where asset management is wholly incidental to regulated activity
• AFIs registered with SFC for Type 1 and/or 2 activities (dealing in securities and/or futures contracts) where asset management is wholly incidental to regulated activity
• Certain members of staff of such AFIs where activity is wholly incidental to Type 1/Type 2 activities
• Solicitors, counsel, professional accountants and trustees who provide asset management services wholly incidental to their professional practices

Collective Investment Scheme (CISs)

Key elements are:

• Arrangement to manage property where day-to-day management is not under control of scheme’s participants and:
  Property is managed as a whole by or for person operating arrangement
  Participants’ contributions and accruing profits or income are pooled
• Purpose of the arrangement is to enable participants to receive profits, income or other payments or returns from property or dealings related to it

However, definition specifically excludes:Arrangement where participants and operator are in same group of companies

• Franchise arrangements
• Arrangements where solicitor holds money for clients in professional capacity in course of his work

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

2. Authorization of Collective Investment Schemes (CISs)

• CIS must be authorized by SFC to be offered to the public in Hong Kong
• Part V of SFO provides powers for SFC to regulate offering of investments, and the advertising of these investments, in Hong Kong.
• SFC may, for both the advertisement and the offering:
  • Grant authorization subject to additional conditions
  • Withdraw authorization once given
  • Refuse authorization
• SFC requires details of an approved individual to receive notices and decisions
• SFC must approve all advertisements, invitations and documents which invite the public to:
  • Enter into an agreement to acquire, dispose of, subscribe for or underwrite securities
  • Enter into a regulated investment agreement
  • Acquire an interest in or participate in a CIS
• Documents exempt from SFC authorization include:
  • Prospectuses complying with Companies Ordinance
  • Listing and other documents approved by HKEx
  • Documents issued by certain licensed corporations (for securities, holders of Type 1, 4 or 6 licenses and for futures contracts, holders of Type 2 or 5 license)
  • Advertisements for securities or CISs which will only be sold to professional investors

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

3. Open-ended Fund Companies (OFCs)

• SFO provides for the creation and regulation of OFCs with limited liability and variable share capital, providing them flexibility to meet investor applications and redemptions
• OFCs are a form of CIS
• Core aspects of this legislative provision include:
  • It is an offence punishable by fine/imprisonment to carry on as an OFC without being SFC registered
  • Key requirements for incorporation/naming/registration of an OFC
  • How shares are to be issued/redeemed and priced
  • Administration and operation of an OFC, including details of directors, investment manager, custodian and auditor
  • An OFC’s disclosure and reporting obligations and governance standards to be complied with
  • SFC regulatory powers regarding OFCs
• It is intended that the OFC regime will allow an overseas corporate fund to re-domicile to Hong Kong
• SFC has the power to make subsidiary legislation and issue codes/guidelines regarding OFCs. See Topic 2 for coverage of the Securities and Futures (Open-ended Fund Companies) Rules and Topic 3 for coverage of the Code on Open-ended Fund Companies (OFC Code)

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

4. Distributors

• AFIs, independent financial advisers, securities dealers, financial planners and insurers
• Asset managers may distribute directly to investors
• Require Type 1 license for dealing in securities, unless exempt
• If activity is solely for purpose of Type 9 activity, then likely to be exempt
• If only introduces business, holds no client assets and does not incur any liabilities, then can apply to be an “approved introducing agent” which still requires Type 1 license but will have much lower capital requirements

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

5. Online Platforms

• With the development of online distribution and advisory platforms, the SFC has issued Guidelines on Online Distribution and Advisory Platforms (ODAP Guidelines) – operational from 6 April 2019.
• The ODAP Guidelines comprise of 5 main parts:
  • Core principles covering platform design, information for clients, risk management, governance, review and monitoring and record keeping
  • General requirements applying to conduct requirements, offer of investments and materials posted on platform
  • Requirements regarding “robo-advice” – advice using algorithms
  • Triggering of suitability requirement and how it is properly discharged
  • Requirements regarding complex products – products unlikely to be understood by retail investors

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

6. Corporate Professional Investors

• If the licensed/registered person is satisfied that the corporate PI:
  • Has an appropriate corporate structure
  • Has appropriate investment processes and controls
  • Has investment decision makers with sufficient investment background and experience
  • Is aware of the risks involved in terms of the person(s) making the investment decisions

THEN the Corporate PI is exempt from all Code of Conduct requirements waived

• Separate assessments should be made in respect of different product types or markets
• If there has been no investment activity in a particular product or market for more than 2 years, an additional assessment should be made

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

7. Anti-Money Laundering and Counter-Terrorist Financing (Financial Institutions) Ordinance

• Objective is to enhance Hong Kong AML regime for the financial sector, including banking, securities, insurance and remittance and money changing.
• Since March 2018, AMLO has been extended to cover non-financial businesses including solicitors, accountants, real estate agents trust and company service providers. Primary concerns are:
  • customer due diligence (CDD) requirements
  • record-keeping requirements
  • powers of relevant authorities (SFC & HKMA) to investigate and supervise LCs and RIs for AMLO compliance and then to discipline, if appropriate
  • establishment of a disciplinary review panel
• A breach of the AMLO is a criminal offence
• Employees/managers of LCs/RIs who knowingly cause/permit the corporate entity to breach the AMLO, are committing a criminal offence – maximum penalty is HK$1m and 2 years in prison
• If fraud is involved, the maximum penalty will be a fine of HK$1m and 7 years in prison
• A breach of the AMLO by a LC/RI can lead to regulatory discipline
• AMLO empowers certain bodies as a “relevant authority” with various powers, including investigation and prosecution. The relevant authorities are:
  • Licensed corporations: SFC
  • Authorised institutions: HKMA
  • Insurance companies:  Insurance Authority

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

8. Guidance Note: Co-operation with the SFC

• The SFC will reduce the type of sanction (from revocation of a license to suspension) or monetarily by up to 30% if the intermediary co-operates with the disciplinary proceedings
• Ways of cooperating with the SFC include:
• Voluntarily and promptly reporting any breaches or failings to the SFC
• Providing true/complete information regarding breaches/failings
• Bringing the disciplinary case to an early conclusion by accepting liability
• Taking steps to contain breaches and making prompt client compensation

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

9. Corporate Governance

• Corporate governance can be improved through:
  • Installing appropriate checks and balances, such as separating the functions of Chairman and CEO, appointment of non-executive directors, establishment of independent audit committees and setting up of remuneration and benefit committees
  • Increasing transparency and disclosures to shareholders / stakeholders /public
  • Adopting international accounting/auditing standards
  • Installing strong protective structures for minority shareholders, creditors and other lenders
  • Identifying and penalizing corporate wrongdoing
• Corporate governance deficiencies can lead to insider dealing, fraud and connected transactions which are undervalued

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

10. MPF Trusteess

• Under MPFA, all MPF schemes must be operated by a trustee approved by the MPFA in one of the following categories:

Corporate Trustee incorporated in Hong Kong with:

• Paid up share capital and net assets of at least HK$150 million
• At least five directors who are suitable (sufficient skills, knowledge, expertise, good reputation and character)
• Ability to carry on business and have proper internal controls
• Sufficient presence and control in Hong Kong (chief executive officer must reside in Hong Kong and day to day business and records must be in Hong Kong)

Corporate Trustee incorporated outside Hong Kong:

• Must meet same requirements above
• Be incorporated/registered in a jurisdiction with laws comparable to Hong Kong
• Be supervised by an offshore authority acceptable to the MPFA
• Designate one of its controllers as its Hong Kong CEO

Individual Trustee: Only for employer-sponsored schemes with individual resident in Hong Kong, of good reputation and character and providing a performance guarantee for 10% NAV of scheme up to HK$10 million

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

11. MPF Intermediaries

• Persons who sell, market or give advice on MPF schemes must register with the MPFA
• There are two categories of MPF intermediary that must register with the MPFA:

Principal Intermediary

• Primary requirement is “principal intermediary” registration
• Must either be licensed with the IA or be SFC Type1 or 4 licensed
• Must apply for approval of either a subsidiary intermediary or an individual who will carry out MPFSO regulated activities
• Must apply for approval of an individual to act as a responsible officer

Subsidiary Intermediary

• Companies or individuals attached to a principal intermediary for the purpose of carrying out regulated activities will need to be registered as a “subsidiary intermediary”
• Must have been registered as a subsidiary intermediary within the last three years or passed a qualifying exam

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

TOPIC 2 – BACK-OFFICE COMPLIANCE

12. Notifications to the SFC

• Under Section 135 of the SFO, a person licensed by or registered with the SFC must report to the SFC:
  • Notice of intention to cease conducting the regulated activity as soon as possible or not later than seven business days prior to intended cessation date
  • Notice of intended change of business address at least seven business days’ in advance
  • Any changes to information supplied to the SFC within seven business days of change (covering representatives, responsible officers or substantial shareholders)
  • Notice of any change of directors within seven business days of change

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

13. Breaches of Laws and Regulations

• Intermediaries are required under the Code of Conduct (para. 12.5) to report to SFC immediately any material or suspected breach, infringement or non-compliance by itself, an employee or an appointed agent with any law, rules, regulations, codes and guidelines administered or issued by the SFC and the requirements of any regulatory authority which apply to the licensed or regulated person

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

14. Client Securities Rules

• The Client Securities Rules (CSR) apply to intermediaries and their associated entities
• The CSR do not apply to trust companies providing custody services to authorized CISs
• The CSR do not apply where the client maintains his securities in an account in his name with a person other than the intermediary or its associated entity
• CSR only apply to Hong Kong stocks (not overseas stocks) received or held in Hong Kong by an intermediary or associated entity in the course of conducting a regulated activity
• An asset manager may sell client securities or settle a sales order on behalf of a client with the written agreement of the client

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

15. Financial Resources Rules

• Financial Resources Rules (FFR) contain general capital requirements for licensed corporations, covering paid-up share capital and required liquid capital (RLC) – they do not apply to registered institutions
• Licensed corporations must keep records in sufficient detail to establish if requirements have been complied with and make information available to SFC within five business days
• Licensed corporations must report as soon as practicable to SFC, if they cannot meet capital requirements and should cease to carry on activity.
• SFC may suspend license or allow corporation to continue to trade subject to certain conditions

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

16. Client Money Rules

• The Client Money Rules prescribe how licensed corporations and their associated entities should deal with client money received or held in Hong Kong
• The Rules do not apply to client money that:
  • Is received or held outside Hong Kong
  • Is moved outside Hong Kong
  • Is held in a bank account by the client in his own name
• Client money to be safeguarded includes all amounts received by the licensed corporation or its associated entity, from or on behalf of clients, less amounts due from the clients and any proper charges due
• The licensed corporation/associated entity holding client money should have one or more segregated accounts (designated as a trust or a client account) maintained with an AFI or another SFC-approved person (ie open a separate bank account)
• If any money held in a segregated account is found to be not client money, the licensed corporation or AE must move it out within one day of being aware of the fact.
• Interest received on client money is due to the client unless otherwise agreed in writing
• Fund subscription money must be deposited in a segregated account if held for more than 2 business days

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

17. Monthly Statements of Account

• Monthly statements must be issued within 10 business days of the month-end
• No statement needed when no activity during the month and no balances at the end of the month
• An asset manager does not need to prepare monthly statements for authorized CISs that it manages
• Monthly statements must include:
  • Asset manager’s trade name
  • Asset manager’s business address
  • Client’s name, address and account number
  • Date of preparation of the statement
  • Month-end valuation of assets with:
    • Quantity, market price, cost and value of each security
    • Details of all open positions
    • Money balance held
    • Amounts payable and receivable
  • Income credited and charges levied during month
  • List of all contracts entered into during month

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

18. Operators of Open-ended Fund Companies (OFCs)

• Directors
  • Initial directors will be identified at the time of incorporation
  • If the OFC is required to hold AGMs, directors should be appointed at such meetings, otherwise the power to appoint directors resides with the directors
  • Directors can be removed at any time by ordinary resolution
  • A register of directors should be available for inspection by shareholders
  • Where a director has an interest in a transaction with the OFC, it should be declared to other directors
• Custodian
  • Directors may appoint a new custodian, subject to receiving prior SFC approval
  • When a custodian is terminated and replaced by a new custodian, it must make a statement regarding any circumstances that should be brought to the attention of the OFC’s shareholders or creditors
• Investment Manager
  • Directors may appoint a new investment manager, subject to receiving prior SFC approval
• Auditor
  • Every OFC must have an auditor appointed by the directors
  • The auditor can be removed by ordinary resolution at a general meeting

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

19. OTC Derivative Reporting – Record Keeping

• Transaction records must be kept for at least five years after the termination or maturity date
• Records must be sufficient to demonstrate compliance with reporting requirements
• Where a licensed corporation is exempt from reporting, records should still be kept to justify the exemption

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

20. Open-ended Fund Companies – Shareholder Meetings and Resolutions

• Directors have the power to call general meetings
• Shareholders holding at least 10% of the voting rights can require the directors to call a general meeting and to propose a resolution at the general meeting
• Whether a resolution requires to be an ordinary resolution or a special resolution (at least 75% vote) will be set out in the OFC’s instrument of incorporation
• 14 days’ notice must be given for an ordinary general meeting and 28 days for a general meeting to remove or appoint a director/auditor
• Either the directors of the OFC or not less than 5% of the shareholders may propose a written resolution

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

TOPIC 3 – ASSET MANAGEMENT REGULATIONS

21. Fund Manager Code of conduct (FMCC)

• Applies to Fund Managers who are licensed/registered with the SFC, and whose business involves the management of:
  • CISs, whether or not the CIS is authorised; and/or
  • Discretionary accounts, whether in the form of an investment mandate or a pre-defined model portfolio (Discretionary Accounts)

Note: FMCC has slightly different provisions to each of these two categories

CIS: “fund” and “client” refer to the CIS; “fund investors” refers collectively to investors in the CIS

Discretionary Accounts: “fund” and “client” refer to the Discretionary Account; “fund investors” refers to Discretionary Account Clients

• FMCC has four parts and sets the minimum standard of conduct for Fund Managers
• Breaches of FMCC impact a person’s fitness and properness, which may have licensing and discipline implications
• FMCC does not have legal force
• Many of provisions are similar to Code of Conduct, with specific provisions for Fund Managers – where there is any inconsistently between applicable provisions, the more stringent provision will apply

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

22. FMCC – Staff Dealings

• Relevant persons are directors or employees of a Fund Manager:
• Who make or participate in investment decisions or who acquire information on investments or decisions before buying or selling the investments
• Whose functions relate to recommendations on buying or selling
• Any person who they control or influence
• Relevant persons must give clients priority and avoid conflicts of interest
• Relevant persons should:
• Disclose investment holdings on joining and at least annually
• Obtain written permission from the compliance officer to make personal account dealings; written permission should be only valid for 5 days or less
• Not buy or sell an investment on their personal account on the same day as the Fund Manager has a similar order for a client
• Not buy or sell an investment on their personal account within one trading day before a client transaction or recommendation by the Fund Manager (unless trade executed and conflict no longer exists)
• Not enter into cross trades with clients
• Not short sell securities recommended by the Fund Manager
• Not invest in IPOs available to clients of Fund Manager
• Hold investments for at least 30 days, unless written permission to dispose of earlier is given
• Hold all personal accounts with the Fund Manager (or obtain permission to use outside brokers and provide copies of all statements)
• Not delay settlement
• Fund Managers must keep separate records for transactions of all relevant persons and maintain audit trails

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

23. FMCC – Cross Trades

• Cross trades between client accounts are allowed if:
• The trades are in the best interests of both clients
• The trades are in line with the clients’ investment objectives
• The trades are at arm’s length at current market values
• The activity is disclosed to the clients
• The reasons are documented prior to executing the trades
• Cross trades between the house account (the account of the Fund Manager) and clients require prior consent of the client, who should be aware of the potential conflict of interest
• Cross trades between staff accounts and clients should not be permitted

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

24. FMCC – Portfolio Valuations by Fund Managers

• All client assets should be regularly valued as per the constitutive documents of the CIS
• The basis of the valuation should be disclosed to clients
• Basis for valuation of client assets:
• Listed shares: a consistent basis for listed shares (opening, mid, closing or average price) using an independent source
• Unlisted shares and unquoted securities: cost adjusted with reference to:
  • Comparable third-party transactions
  • Appraisals by qualified accountants, appraisers or credit rating agencies for other investments
  • Other relevant general information
• Units or shares in CIS should be valued at latest quoted prices
• Value of listed securities which are not actively traded or suspended from trading should be monitored with procedures to:
  • Actively seek independent price confirmations from brokers/market makers
  • Where appropriate, write down or write off such securities in the fund account
  • Decide whether to transfer such securities to the fund manager’s own account and at what price
• NAV calculations should be performed as per the constitutive documents (does not apply to Discretionary Account Managers)
• Internal records should be reconciled to third party documentation at least monthly
• All interests in securities should be disclosed
• In some circumstances, a fund manager may segregate illiquid or difficult-to-value assets into so-called “side pockets”
• Where an asset is moved into a side pocket, clear disclosure must be made to fund investors of asset being moved, valuation at time of move and ongoing asset valuation
• Provisions regarding side pockets do not apply to Discretionary Account Managers

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

25. CISs – Disclosure Requirements

• The Handbook for Unit Trusts and Mutual Funds lists appropriate disclosures to be made in the offering document
• A product key facts statement (Product KFS) should be part of the offering document, unless stated otherwise in the applicable Code
• A Product KFS is a clear, concise and effective summary of the key information to allow investors to understand the features and risks of the investment product
• Each Product KFS should be no more than four pages and should contain a warning statement on the first page that investors should not decide to invest based only on the Product KFS
• CIS offering documents must meet the CUTMF disclosure requirements, to allow investors to make an informed decision
• Advertisements must comply with applicable advertising guidelines

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

26. Information in Offering Document

• The offering document of a CIS is the “document, or documents issued together, containing information on a scheme to invite offers by the public to buy units/shares in the scheme”
• Offering documents of a CIS must be SFC approved
• Document must be in both English and Chinese (unless SFC waives requirement)
• Full disclosure to help an investor make an informed decision, including:
• Investment objectives and restrictions
• Collateral policy and criteria
• Valuation of property and pricing
• Liquidity risk management
• Types and denomination of units/shares
• Frequency of valuations
• Frequency of dealing days
• Application and redemption procedures
• Details of distribution, fees, charges and tax, if any
• Details of financial reports to be provided
• Financial year-end
• Most recent audited accounts and report
• Any semi-annual report published after latest annual report
• Warnings on need for independent advice
• Instructions on where to find general information or access to other documents
• Evidence to support any performance data or estimated yield
• Product KFS
• Custody arrangements

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

27. Advertising – Performance Information

• Performance data should be calculated, selected, published and sourced on a consistent basis using reasonable measures and reliable sources
• Performance data should relate to first/last dealing days or first/last day or month
• Basis of computation of data should be clearly stated
• No forecasts should be made
• A substantiated prospective yield is generally acceptable if CIS investing in products with regular and stable distributions (fixed income securities, money market instruments, real estate investment trusts)
• Any prospective yield must explain the basis of calculation
• Any prospective yield must also include a warning that a positive distribution yield does not imply a positive return
• There must be a 6-month track record before performance information is produced
• If performance information is used, it must contain the returns of the last 5 years (or period since launch) on a 12-month basis (or periods relevant since launch)
• Regular publications may contain figures for latest periods as long as clearly marked for information and are in the same format as other figures
• Performance data should be up to date and no more than 6 months old
• Performance data for print media, broadcasts and interactive systems should not be more that 3 months old
• Actual data should be used
• Hypothetical figures may be used for purposes of explaining complicated mechanisms
• Comparisons should be fair, accurate and relevant and on a like-for-like basis
• Past records relating to an unauthorized CIS may be used to advertise a newly launched authorized CIS with less than 6 months track record, similar investment objectives, policies and strategies and the same management team

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

28. Valuation and Pricing

• Offer/redemption price = Net asset value (NAV) / number of shares or units outstanding less any fees or charges
• Different types of CIS assets may require different valuation policies and procedures, which should:
  • Be established by the management company, in consultation with trustee/custodian
  • Seek to detect, prevent and correct pricing errors
  • Be consistently applied
  • Be periodically reviewed by the management company to ensure that they remain appropriate
  • Be reviewed and tested annually by a competent, independent person (eg independent auditor)
• Frequency of valuing scheme’s assets must be disclosed in the offering document and cannot be less frequent than every dealing day
• If the management company has to make a fair value adjustment, it must act in goof faith, exercise due skill, care and diligence and consult with trustee/custodian
• Unquoted shares must be valued regularly by a professional person approved by trustee/custodian
• Offer and redemption prices or NAVs must be made public, free of charge, on every dealing day in an appropriate manner, such as newspapers, telephone hotlines and websites
• Pricing errors should be corrected as soon as possible:
• SFC must be informed if error is 0.5% or more of NAV
• Investors should be compensated if total loss to individual investors is more than HK$100
• Management company must bear any loss it suffers

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

29. Transactions with Brokers/Dealers

• Management company or its connected persons should not retain cash or other rebates from brokers or dealers in return for directing business to them
• However, goods and services (“Soft dollar rebates”) may be retained if:
• They are of benefit to the holders of the CIS
• Transactions were at best execution standards
• Brokerage rates are not in excess of normal full-service rates
• There was adequate prior disclosure in the offering document
• CIS annual report discloses manager’s soft dollar practices and goods and services received

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

30. Core Requirements for Authorized CISs

Spread of Investments

• CIS may not hold >10% of its total NAV in securities of one issuer or >20% in one group of companies
• The aggregate amount of cash deposited with a single entity, or entities within the same group, must not > 20% of the CIS total NAV
• CIS may not hold >10% of its total NAV in ordinary shares of any single issuer
• CIS may not hold >15% of its total NAV in shares that are neither listed, quoted nor dealt in on a market (stock exchange, OTC etc)
• Investments of CIS and wholly-owned investment subsidiaries should be added together

However, note exception for Government and Other Public Securities below

Government and Other Public Securities

• CIS may hold up to 30% of its total NAV in Government or other public securities of same issue
• If CIS only holds these types of securities, then CIS must hold at least six different issues

Investment in Other CISs

• CIS may not hold >10% of its total NAV in underlying schemes that are not RJSs and not SFC authorised
• A CIS may invest in a RJS or an SFC authorised scheme, subject to a cap of not more than 30% of its total NAV
• A CIS may not invest in any underlying scheme which invests primarily in investments restricted by CUTMF
• If CIS and investee CIS are managed by same or a connected company, then all initial charges of the underlying scheme must be waived
• The management company of a CIS may not obtain a rebate on any fees or charges levied by an underlying scheme or its management company

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

31. CISs – Other Limitations

• A CIS is prohibited from:
  • Investing in physical commodities (SFC may override on a case-by-basis)
  • Investing in any interest in real estate (shares in real estate companies/REITs permitted)
  • Any transaction involving unlimited liability
  • Any naked or uncovered short selling
• Any security to be short sold must be actively traded on a market where short selling is permitted
• Liability of CIS for short selling may not exceed >10% of its total NAV
• Liability of holders must be limited to their investments in the CIS
• CIS must not acquire securities in an entity where:
• Any individual directors/officers of management company of the CIS owns >0.5% of total nominal amount of all the issued shares in that class
• Directors/officers combined of management company own >5% of securities
• CIS must not own securities with uncalled amounts not covered by freely available cash in CIS assets
• CIS may not borrow >10% of NAV (no limit on back-to-back borrowing)
• A CIS must maintain at least 100% collateralisation when engaging in securities margin financing
• CIS must invest 70% of non-cash assets in relevant investment category if name identifies particular objective, geographic location or market
• Any breach should be rectified within a reasonable time

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

32. Hedge Fund Investment Limits

Minimum initial subscription thresholds:

• Single Hedge Fund: US$50,000
• FofHF: US$10,000
• Hedge Fund with at least 100% capital guarantee: No limit

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

33. Management Companies

• Every authorized CIS must appoint a management company acceptable to SFC
• One exception is a self-managed scheme, where the CIS is managed by its own board of directors. Directors of a self-managed scheme are not allowed to deal with the scheme as principals.  Self-managed schemes are not that common
• A management company must:
• Be principally engaged in fund management
• Minimum issued and paid up share capital and capital reserves of HK$10 million or equivalent
• Amounts due to a holding company can be included within the capital as long as amounts are subordinated to all other liabilities and are not repaid without prior SFC consent
• Have no material lending
• Have positive net assets at all times

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

 34. Trustees/Custodians

• Trustee is expected to fulfil duties imposed under general law of trusts and as set out in trust deed
• Custodians’ responsibilities are set out in constitutive documents and custodian agreement
• Trustees/custodians are not directly regulated by SFC
• However, trustees/custodian must be acceptable to SFC for CIS to be authorized
• SFC specifies certain acceptability and responsibility requirements for trustees/custodians

Acceptability

• A trustee/custodian must be:
  • A licensed bank; or
  • A trust company which is a subsidiary of a licensed bank; or
  • A registered trust company; or
  • A banking institution or trust company incorporated outside of Hong Kong acceptable to the SFC
  • Independently audited
  • Have a minimum issued and paid up and non-distributable capital reserve of HK$10 million or its equivalent
  • Alternatively, is a wholly-owned subsidiary of a substantial financial institution (NAV of HK$2 billion) provided holding company will subscribe for required additional capital and undertakes it will not let its subsidiary default and will not dispose of the subsidiary

Independence

• The trustee/custodian and management company must be independent of each other
• If the trustee/custodian and the management company have the same holding company then they will be taken as independent if:
  • They are both subsidiaries of a substantial financial institution
  • Neither is a subsidiary of the other
  • They do not have a common director, and
  • Both sign an undertaking to act independently

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

 35. REIT Authorisation

• To be authorised by the SFC, a REIT must have the following characteristics:
• A CIS constituted as a trust, not a company
• Invest in real estate that generates recurrent rental income
• Active trading in real estate is restricted
• The majority of income must be derived from real estate rental income
• A significant proportion of income must be distributed as dividends
• A maximum borrowing limit must be defined
• Connected party transaction are subject to holders’ approval
• Real estate covers land or buildings (freehold or leasehold), car parks and incidental assets (eg fixtures and fittings)
• A Hong Kong resident must be nominated and approved by the SFC to be served with notices and decisions
• An SFC authorised REIT must be listed on the SEHK within an acceptable period

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

36. Liquidity Risk Management

Product Design and Disclosure

• Management companies need to understand the profile of the fund’s investors and their historical and expected redemption patterns
• Management companies need to disclose in funds’ offering documents:
• Significance and potential impact of liquidity risks on funds and their investors
• Summary of liquidity risk management process
• Liquidity risk management tools

Ongoing Liquidity Risk Assessment

• Management companies should:
• Regularly assess liquidity profile of fund’s liabilities and assets
• Classify assets into different liquidity categories, setting internal targets/indicators on how much should be invested in each category

Stress Testing

• Management companies should regularly stress test for different market conditions and adequacy of fund’s action plan and risk management tools
• Stress test results should be reviewed by liquidity risk management committee/senior management

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

 37. Mutual Recognition of Funds – Ongoing Requirements

• A Recognised Mainland Fund authorised in Hong Kong must observe the following obligations:

In Home Jurisdiction (Mainland China)

• Remain supervised and regulated by the regulator
• Remain compliant with its constitutive documents

In Host Jurisdiction (Hong Kong)

• Comply with regulations relating to sale and distribution of the fund
• Comply with additional rules in the Host Jurisdiction
• Make constitutive documents available for inspection
• Have a bilingual offering document and a Product KFS – if original documents are in simplified Chinese, traditional Chinese will be required for the Hong Kong documents
• If fund ceases to meet Host Jurisdiction requirements, it must notify Host regulator, cease marketing and stop accepting subscriptions

In Both Jurisdictions

• Ensure that holders of the fund receive fair and equal treatment
• Disclosure information made available in one market must be made available to the other market at the same time (both to investors and regulators)
• Notifications made to the Home jurisdiction regulator must, at the same time, be made to the Host regulator
• Ensure that Hong Kong courts are not excluded from accepting an action concerning the fund
• Changes made to the fund in accordance with Home regulations must be filed with the Host regulator
• Any breach of laws/regulations must be notified to both regulators at the same time

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

 38. MPF Products

• MPF schemes have two or more constituent funds, giving scheme members a choice of investments
• Constituent funds may have direct investments or invest in pooled investment funds
• MPF schemes must be registered with the MPFA
• All constituent funds and pooled investment funds must be approved by the MPFA
• SFC is responsible for authorising MPF schemes, constituent funds and pooled investment funds with an emphasis on vetting/authorising information disclosure and marketing materials
• SFC will authorise pooled investment funds that are only made available to MPF schemes under the SFC Code on MPF Products
• SFC will authorise pooled investment funds that are available to both MPF service providers and retail investors under the CUTMF
• Each MPF scheme is required to provide a Default Investment Strategy (DIS), which is a highly standardised and fee-controlled MPF investment strategy with the objective of building up long-term retirement savings. Scheme members who do not choose their MPF investments, will have their benefits invested according to their scheme’s DIS.  Scheme members can also choose to opt for the Scheme DIS

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

TOPIC 4 – MISCONDUCT

 39. Disclosure of False or Misleading Information Inducing Transactions

• If someone:
  • Makes intentional, reckless or negligent disclosure, circulation or dissemination of false or misleading information as to a material fact or its omission
  • which is likely to induce the subscription, sale or purchase of securities, or dealing in futures contracts, or
  • to increase, reduce, maintain or stabilize their prices,
  • then he is engaged in market misconduct
• A person who transmits or re-transmits the information, acting as a conduit, in good faith, will not be engaging in market misconduct

[For Paper 6 practice questions, go to Examinator.online – Paper 6]

 40. Improper Practices – Churning

• Excessive selling/buying of investments in a fund/discretionary account with the intention of generating higher commission-based fee income
• Not in the best interests of the client

[For Paper 6 practice questions, go to Examinator.online – Paper 6]