HONG KONG: Hong Kong SFC Circular to UCITS Management Companies in respect of derivatives

Wednesday August 23 2006

The Hong Kong Securities and Futures Commission (SFC) has published a circular to fund management companies of SFC-authorized UK, Dublin and Luxembourg UCITS III funds in respect of financial derivative instruments (FDI) usage under UCITS III.

The Guide has been prepared to facilitate the authorization process and contains details relating to the risk management and control process of UCITS III funds that must be provided to the SFC to support applications for the authorization of UCITS III funds which use or will use the expanded investment powers, especially those using FDIs for investment purposes.

The Guide is based upon the European Commission Recommendations on the use of the FDIs for UCITS and so is also comparable with the Risk Management Process documents already being prepared by UCITS in their home Member States.

However, there are a few specific information requests set out in the Guide which are not necessarily or explicitly required by some of the Home regulators. These include requests for the following information:

*A description of the valuation rules for the specified types of FDI, including the policy with regard to the valuation of illiquid FDI and OTC FDI, and in particular, the frequency of valuation and policy on independent verification;

*A summary of policies in relation to the monitoring and management of legal risk, particularly in the context of OTC derivatives and any other relevant risks ;

*Details of the management controls and systems for monitoring trade execution, position netting, monitoring of compliance with internal policies / procedures and quantitative limits, and preventing breaches :

*Policies on collateral and netting :

*Description of internal reporting procedures including the escalation procedures and remedial policy in the event of limit breaches.

The Guide is therefore a useful addition to the growing body of material as to what information should usefully be included in a UCITS risk management process.

This Circular follows upon an earlier circular sent in March 2006 detailing the interim measures on the disclosure submission requirements for the authorization of UCITS III funds, including a fast track procedure for existing UCITS I funds converting to UCITS III which will not significantly amend their investment policy or powers.

As at 30 June 2006, 1,202 UCITS III funds have been approved by the SFC including 158 funds that intent to use FDI for general investment.

The Guide can be found at the above link.