Hong Kong’s SFC set to issue bank-like liquidity guidelines for funds
Industry sources say the changes will be introduced without public consultation, while new rules to rein in fund leverage levels are next
Alarmed by the ever increasing prospect of bank runs and so-called fire sales in investment funds as their accumulated asset size becomes a source of potential systemic financial risk, Hong Kong’s Securities and Futures Commission is set to introduce bank-like liquidity guidelines for authorised investment funds.
Industry and regulatory sources told the South China Morning Post on Tuesday that the SFC has already conducted a “soft consultation” with industry associations and top funds in the market. It is set to release the guidelines “within days” without undertaking a further full public consultation.
The sources also said new rules aimed at capping the leverage level funds will be able to attain are in the works, and will follow after the phased-in introduction of the liquidity rules in the market.
The new rules will classify fund assets into different liquidity categories, against which funds will be asked to hold recommended cash buffers that could be used to meet potential liquidity events.
It also sets out regulatory expectations for the composition of fund balance sheets, fair valuation, stress testing requirements, and governance requirements creating escalation channels to dedicated, independent risk management staff in the case of market liquidity events.
Most importantly, the regulator wants fund-invested assets and investment strategies to be in line with their liquidity and redemption policies promised to investors to prevent fire sale events in the future, the sources said.
If the SFC requires funds in Hong Kong to hold 5 per cent of such assets in cash or cash-equivalent as liquidity reserves, the industry may need to convert some US$110 billion of assets into ready cash to meet the latest regulatory guidance. According to the SFC’s last available statistics, US$2.27 trillion worth of assets are managed by the funds industry in the city.
Speaking at the Asia Securities Industry & Financial Markets Association (ASIFMA) market liquidity conference on Tuesday, Julia Leung, SFC executive director in charge of investment products, explained that the regulator’s rationale in introducing the rules was inspired by the near “fire sales” observed in recent market events.
“Some markets, such as emerging market fixed income securities, are known to be illiquid and investors are alert to this. But equities markets are generally seen as liquid,” Leung said. “Events in the past 12 months have challenged this accepted wisdom.
“First there was the A- share market correction last summer. More than half of the listed stocks suspended trading after hitting price fall limits or citing various reasons to voluntarily suspend trading. Then there was the short-lived circuit breaker, which brought the whole market to a standstill multiple times in the first week of 2016. During these episodes, fund managers were rudely awakened to the fact that, actually, equities could be illiquid too,” she said.
The industry and the regulator were still wrangling over whether the capital buffers should be “targets” versus “indicators” in the coding of the new rules. Leung believes the two words are the same, although the industry would argue the former would imply regulatory preference, whereas the latter would leave it a company internal matter. The final wording may produce different regulatory outcomes for the regulated funds involved.
This article has been amended to remove references to preferred and internal targets in the fourth and 11th paragraphs.