Hong Kong SFC Chief Warns on Leverage and Conduct

Ashley Alder, the chief executive of the Hong Kong Securities and Futures Commission and newly appointed chairman of the International Organisation of Securities Commissions ("IOSCO"), has flagged liquidity risk, leverage and conduct as areas which will receive more attention in the years ahead. 

In a recently released speech that was delivered on June 22 at a Hedge Fund Standards Board roundtable, Alder said IOSCO and the Financial Stability Board ("FSB") were looking at the use of leverage within funds, and hedge funds in particular, and would issue a consultation on this topic shortly. 

For hedge funds, which generally have no cap on leverage, attention was now on the use of derivatives to create synthetic leverage and the absence of consistent standards for measuring leverage, both within and across jurisdictions, he said. Alder noted that traditional balance sheet leverage, frequently used by funds to boost investment returns, was central to the failure of Long-Term Capital Management in 1998 and the collapse of two Bear Stearns hedge funds in 2007. 

"These failures showed that leveraged funds not only affect their largely non-retail investors, but also have systemic risk implications," he said. 

In Hong Kong, where private funds are not directly regulated – but the activity of asset management is – the SFC was planning a consultation on developing consistent leverage measurements and to collect leverage data on private funds in the second half of the year, he said. 

Another area of focus for the SFC is liquidity risk management, he said, with the regulator considering the need to give guidance to implement existing IOSCO principles, including the requirement to conduct regular stress tests.

In terms of conduct issues for the asset management industry, the SFC has begun a review of conduct expectations with a view to strengthening regulations in areas such as the responsibilities of fund managers, including on disclosure of commissions and independent advice, he said.

Insider dealing was also an area of focus, he said, with some firms in Hong Kong not yet having implemented proper surveillance or transaction monitoring to monitor irregular trading patterns. 

"We are urging firms to make sure they have proper insider dealing surveillance in place," he said. "This may include examining trading patterns and investigating any unusual ones; monitoring trades in relation to specific events such as public announcements, price spikes and significant profits, and tracing the source of information obtained by fund managers and analysts before conducting trades. Email and phone log surveillance is important here. We continue to see control weaknesses during our inspections, for example, when functions are delegated or outsourced."

He said many of the problems encountered were related to outsourcing, with documentation that does not define the services to be provided, or which involve inconsistencies between internal fund policies and the service contract. In some cases, he added, there was no documentation to show any monitoring or review of the outsourced functions or any due diligence.


North Asia editor for Thomson Reuters Regulatory Intelligence. He is based in Hong Kong.