When we live in a regulatory environment which changes as often as it has in recent years, it’s easy to become jaded by the never-ending stream of compliance news. Let’s cut through the noise with recent, salient examples of the consequences when specific aspects of compliance are not attended to. Cases where regulators actually TELL us why certain sanctions were imposed are helpful in putting a finer point on what can seem only theoretical.
In the area of shareholding disclosure for short positions, we have such an example. More importantly, there are some lessons to be learnt from it.
On February 22, 2021, the Securities and Futures Commission (SFC), the regulator in Hong Kong, publicly reprimanded and fined an asset manager HK$3.15 million over failures to accurately comply with the short position disclosure regime there. We have often written about the risk of regulatory sanctions but it’s instructive that in this case, the SFC outlined the reasons behind the failures.
I would like to highlight two of the errors identified:
1. Incorrect Aggregation Logic:
According to the SFC, the holder “mistakenly calculated the short positions held by all CISs1 under its management on an aggregated basis, and reported all such short positions under the name of one of the four CISs.”2 They did so “instead of separately calculating and reporting the net short positions of each CIS as required under the SPR Rules.”3
Ensuring that one is aggregating and netting long and short positions at the right level in a given corporate tree is one of the more complicated yet vital aspects of disclosure to get right. The regulation in jurisdictions can differ in regard to where the regulators want assets to be aggregated, net, calculated and disclosed. In addition, those nuances can depend on your firms’ unique relationship to assets, which types of portfolios or legal structures are represented (e.g. UCITS, trusts, separately managed accounts, etc.), and even include understanding disaggregation and delegation. In fact, for this particular case in Hong Kong, if a CIS has sub-funds, the netting must be done at sub-fund level. The CIS’ involved in this case may not have had sub-funds, but if they did, another error might have occurred.
At FundApps, we have focused on these important aspects of aggregation for many years and continue to test and enhance our aggregation model to ensure accurate results. In the case of our Short Hong Kong Rules, our rules have always ensured that netting was done at the level of a CIS (or sub-fund of an umbrella CIS), and not just aggregated to the asset manager.
Are you sure your firm is aggregating assets at the right level depending on 100+ countries one might have regulatory exposure to?
2. Incorrect Denominator:
According to the SFC, the holder “erroneously used data sources that included the market capitalisation of A-shares and non-listed shares of the issuers in calculating whether the net short positions held by the CISs exceed the 0.02 per cent reportable threshold instead of only using the market capitalisation of Hong Kong-listed shares as required by the SPR Rules in making the calculation.” The Summary of Facts noted that the holder just used the denominator “downloaded from Bloomberg.”
Here at FundApps, we worked hard with our engineers to ensure that the special denominator for this regime could be provided for our clients and integrated automatically in our Hong Kong rules! In fact, we wrote about this in our May 2017 “Dizzying denominators” article. Our clients rest easy knowing that a team of compliance experts and a growing community of compliance peers using the SAME rule set ensures compliance.
We’ve also noted that incorrect denominators are one of the major reasons disclosures are missed and have also developed unique functionality which allows our clients to cross reference denominators.
A word about the penalties. Although the monetary fine of roughly HK$ 3.15 million might be painful, the reputational risk related to the public sanction of the firm should be considered more severe. Financial institutions rely fundamentally on the public’s trust and ensuring your firm is not harmed by public reprimand should be a high priority.
The good news is: these challenges can be tackled! If you have not considered how compliance-as-a service can demonstrably reduce your financial and reputational risk, then we hope to have a conversation with you about this.
If you are not able to honestly and comfortably assert that nuances like the ones described above are fully covered at your firm, we’d love to hear from you.
1 Collective Investment Scheme
3 Statement of Disciplinary Action: https://apps.sfc.hk/edistributionWeb/api/news/openAppendix?lang=EN&refNo=21PR20&appendix=0