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Legal Update

Hong Kong SFC Enforcement Action Highlights Conflicts of Interest of Connected Persons

27 July 2016
Mayer Brown Legal Update

A recent disciplinary proceeding brought by the Securities and Futures Commission (SFC) of Hong Kong against the investment manager (the Manager) of an SFC authorised exchange traded fund (ETF) highlights the importance of ensuring that interest received on a deposit made by, or on behalf, of an SFC authorised fund with a connected person matches prevailing commercial rates for a deposit of that size and term.

During the relevant period, the Manager deposited uninvested cash balances with its connected person (the Connected Person within the meaning of SFC's Code on Unit Trusts and Mutual Funds (UT Code)) and no interest was earned.

While the Manager's procedures included the checking of interest rates offered by other banks, that checking assumed that the Connected Person's overnight rate would always exceed the Connected Person's on call deposit rate.

The Manager's procedures failed to adequately consider placing cash balances on deposit with the Connected Person at a rate other than the overnight rate.

The Manager's procedures also failed to undertake a comparison with banks other than the Connected Person, with reference to the size and term of the deposit, as required by the UT Code.

SFC Findings

The SFC found that, in managing the cash balances of the ETF, the Manager did not:

  1. ensure that interest received on deposits made with its Connected Person at least matched the prevailing commercial rate for a deposit of that size and term in accordance with paragraph 10.10 of the UT Code and paragraph 3.9 of the Fund Manager Code of Conduct;
  2. manage the ETF's assets in accordance with its trust deed which permits cash to be placed by the Manager with its connected persons provided that it is deposited in an interest bearing account at a market rate of interest;
  3. have adequate policies and procedures in place regarding deposits in accordance with paragraph 1.2(c) of the Fund Manager Code of Conduct;
  4. provide accurate information regarding the deposits as the ETF's interim and annual financial statements, as at the relevant period end dates, incorrectly described the cash balances as being placed in a "non-interest bearing current account" in breach of General Principle 6 of the Overarching Principles in the SFC Products Handbook which requires product providers to discharge their functions with due skill, care and diligence; and
  5. avoid situations where conflicts of interest may arise (General Principle 4 of the Overarching Principles in the SFC Products Handbook) and/or failed to manage and minimise the conflict by putting appropriate safeguards and measures in place where the conflict could not be avoided, in order to protect investor's interest (paragraph 4.2 of the Overarching Principles in the SFC Products Handbook).

Lesson To Be Learned

While the placing of cash balances by the Manager with the Connected Person is not prohibited, reference should always be made to the applicable provisions of the fund's trust deed to determine how the conflict of interest between investors and the Connected Person in such circumstances should be addressed and managed. In addition, paragraph 10.10 of the UT Code and paragraph 3.9 of the Fund Manager Code of Conduct specifically require that interest must be received on the deposit at a rate not lower than the prevailing commercial rate for a deposit of that size and term.

By not following the requirements of the UT Code and the Fund Manager Code of Conduct when depositing cash balances with the Connected Person, the Manager failed to manage and minimise the conflict between the interests of investors and the interests of the Manager/the Connected Person.


The SFC reprimanded the Manager and imposed a fine pursuant to section 194 of the Securities and Futures Ordinance after having taken into account that the Manager:

a. co-operated with the SFC in resolving its concerns;

b. agreed to make a voluntary payment to the ETF;

c. agreed to commission an independent review of its cash management policy and procedures in respect of its SFC authorised funds; and

d. had a clean disciplinary record in relation to its regulated activities.

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