LegCo Subcommittee on MPF System
Information Note
Investment Management

Purpose

This paper describes the proposed requirements on the investment management of MPF schemes -

  1. investment arrangement (paragraphs 2 to 4 below);
  2. control and supervision of investment managers (paragraphs 5 to 10 below);
  3. statement of investment policy and objectives (SIPO) (paragraphs 11 to 13 below); and
  4. investment practices (paragraphs 14 to 16 below).

Proposal

Investment Arrangement

Portfolio Managed by a "Qualified" Investment Manager

2. We propose that where a scheme maintains a segregated investment portfolio, the trustee is required to engage an investment manager that is incorporated in Hong Kong with capital and net assets of at least HK$10 million and is a registered investment adviser with the SFC.

Passive Investment Arrangement

3. We propose that the trustee could adopt a "passive investment arrangement" by using approved pooled investment vehicles.

A Combination of Investment Arrangements

4. We propose that the trustee could adopt a combination of the investment arrangements stated in paragraphs 2 and 3 above.

Control and Supervision of Investment Manager

Independence from the Trustee and Custodian

5. We propose that the investment manager should be independent from both the trustee and the custodian. If the investment manager has the same ultimate holding company as the trustee/custodian, the investment manager is deemed to be independent of the trustee/custodian only if -

  1. their parent company is a substantial financial institution;
  2. neither one of them is a subsidiary of the other;
  3. no person is a director of both entities; and
  4. both entities sign an undertaking that they will act independently of each other in their dealings with the scheme.

Selection Process of Investment Manager

6. We propose that the selection process should be properly documented and in the opinion of the trustee, the investment manager should have -

  1. no conflict of interest with other service providers of the scheme;
  2. proper staff and resources to carry out investment management; and
  3. adequate internal controls and safeguards with regard to investment dealing and settlement procedures.

Investment Manager’s Delegation of Duties

7. We propose that the investment manager could, subject to the approval of the trustee, delegate the investment management of part or all of the scheme assets to an associated investment management company which is -

  1. registered with the SFC; or
  2. subject to an "acceptable supervisory regime" in its country of establishment as construed by the SFC.

Investment Management Agreement

8. We propose that there should be an investment management agreement between the trustee and the investment manager containing at least the following -

  1. provisions of the Client Agreement under section 6 of the SFC’s Code of Conduct for Persons Registered with the SFC;
  2. provisions to enable the trustee to require the investment manager from time to time to provide -
    1. appropriate information as to the making of, and return, on the investments; and
    2. such information as is necessary to enable the trustee to assess the capability of the investment manager to manage the investments of the scheme;
  3. whether the agreement precludes any other agreements that any of the contracting parties may have or intend to have;
  4. whether the agreement may be terminated by either party and the notice period;
  5. that the agreement may be terminated in the event of a winding-up or liquidation of the investment manager, or in the event that the investment manager makes any arrangement with its creditors; and
  6. that the agreement is governed by the law of Hong Kong.

Reporting and Disclosure Requirements for the Investment Manager

9. We propose that the investment manager should inform the trustee within 30 days regarding any change to any key areas relating to the investment management of the scheme. The trustee will inform the investment manager of the areas it deems "key" at the time of appointment.

10. Furthermore, the investment manager must declare to the trustee -

  1. any relationship, through a shareholding or directorship between the investment manager and other service providers of the scheme; and
  2. any arrangement where fees, commissions and payments are received from, paid to or shared with a third party or service provider as a result of an agreement to manage or generally give advice on the assets of the scheme, and disclose the amount of such sums.

Statement of Investment Policy and Objectives (SIPO)

Content of the Statement

11. We propose that the trustee should formulate a SIPO for the scheme which forms part of the investment management agreement with the investment manager. The SIPO should include -

  1. primary investment objective of the scheme;
  2. policy concerning:
    1. the kind of investments held;
    2. the balance between different kinds of investments;
    3. risk of the investment strategy of the overall portfolio;
    4. expected returns of the overall portfolio; and
  3. the liquidity requirements of forecast cash inflows and outflows where applicable.

Regular Review of the Statement

12. We propose that the SIPO be reviewed by the trustee at least once a year and be confirmed or amended.

Reporting Requirements

13. We propose that the SIPO should form part of scheme registration documents and the annual report to the MPFA. The trustee should also make it available to scheme members upon request.

Investments Practices

Investments at Arm’s Length

14. We propose that the trustee or the investment manager, as the case may be, and any other party involved in any financial transactions must deal with each other at arm’s length. Where they are dealing with connected parties, the terms and conditions of the transaction should be not less favourable to the scheme than those which it is reasonably expected from parties dealing at arm’s length.

15. Furthermore, the investment manager’s dealing with an associated stock broker, bank or other market maker should in aggregate not exceed 50% of the total transactions in a year. All brokerage and commissions with connected parties should be disclosed separately to the trustees.

Fair and Equitable Treatment in Financial Transactions

16. We propose that the trustee and the investment manager should be required to provide fair and equitable treatment to all MPF schemes under their management in all financial transactions including the purchase and sale of securities and currencies.

Cash Commission Rebates and Soft Dollar Benefits

17. We propose that SFC’s requirements on cash commission rebates and soft dollar benefits for authorized unit trusts and mutual funds should be adopted which prohibits cash rebates. Where the trustee of a scheme allows the investment manager or its connected parties to retain soft dollars, it should be explicitly stated in the investment management agreement.

Justification

Investment Arrangement

Portfolio Managed by a "Qualified" Investment Manager

18. A Hong Kong based investment manager of size and substance and under the supervision of the SFC is of some comfort to the members of an MPF scheme. Local presence also facilitates communication.

Passive Investment Arrangement

19. Our proposals would permit trustees to select "off-the-self" investment products. However, these products should comply fully with MPF investment restrictions and guidelines and be managed by qualified investment managers meeting MPF requirements.

A Combination of Investment Arrangements

20. The proposal in paragraph 4 above will provide the trustee with flexibility in the investment management of scheme assets whilst ensuring that the investment function is carried out within the boundaries of the MPF investment standards and guidelines.

Control and Supervision of Investment Manager

Independence from the Trustee and Custodian

21. It is an international requirement for collective investment schemes that the investment management function be carried out by an investment manager independent from the trustee/custodian of the scheme. From the investment point of view, an MPF scheme is a kind of collective investment scheme and thus should be subject to this separation of function providing the necessary checks and balances to prevent fraud.

22. The independence of the investment manager from both the trustee and custodian is in line with SFC requirements for authorized unit trusts and mutual funds.

Selection Process of Investment Manager

23. Trustees are expected to exercise prudence and due care in selecting the investment manager. A properly documented process for engaging the investment manger would enhance the transparency of the selection process and open it up to possible public scrutiny. This would ensure that the method of selection and other factors, such as fees, investment management process and internal controls, that were taken into consideration in the selection process would be satisfactory.

Investment Manager’s Delegation of Duties

24. In the management of a global portfolio, investment managers cannot always operate entirely from Hong Kong and need to delegate to their associates overseas with the relevant expertise. Many of the leading investment management companies in Hong Kong are subsidiaries of foreign investment management companies with international networks. It is common practice for a local investment management company to delegate the investment management of foreign securities to a fellow subsidiary or associate incorporated and operating outside Hong Kong.

25. The proposed standard will require the delegate to be an investment management company meeting minimum standards so that the investment of scheme assets will be handled by professional investment managers. It is an onus for the investment manager to demonstrate to the trustee that the delegate possesses the necessary investment expertise and is registered with the appropriate authority. The principal investment management agreement will continue to be with a Hong Kong company of substance. Delegation will not reduce or dilute any obligations the appointed investment manager has.

Investment Management Agreement

26. It is established good practice to enter into an investment management agreement with the investment manager as well as obligations of the investment manager to follow the SFC Code of Conduct. The investment management agreement would determine the mode of operation of investment management arrangements, relationship between the investment manager and other parties and its impact on the scheme , and the investment practices that are acceptable to the trustee.

Reporting and Disclosure Requirements for the Investment Manager

27. The requirement for the investment manager to report key changes to the trustee will enhance the transparency of investment activities. It will also enable the trustee to make, whenever necessary, timely decisions for the benefit of scheme assets. The key areas of changes may include such items as particular personnel, the style of investment management, location of office and systems.

Statement of Investment Objectives and Policy (SIPO)

Content of the Statement

28. The SIPO is a standard requirement in many developed countries’ (such as Australia, Canada and the UK) retirement scheme legislation. The requirement for a SIPO will force the trustee to make clear the investment policy and objectives of an MPF scheme and provides guidance to the investment manager. In making investment decisions, the investment manager would have to consider whether they are consistent with the SIPO. The trustee may work with the investment manager or seek appropriate professional advice in order to draw up the statement.

29. The primary investment objective would summarise the objective of the overall scheme. A typical example of the statement would be "to achieve in the medium to long term as high an investment return as possible while ensuring that the chance of achieving a negative return over any one year is very low."

30. The policy concerning the kind of investment held will detail the various types of asset classes in which the scheme will invest and what restrictions may be imposed in addition to MPF investment restrictions and guidelines; whether the scheme will use derivatives and to what extent; whether the scheme will participate in the practice of security lending, etc. The statement would specify the long term strategic benchmark weightings for each of the asset classes. In addition the statement should highlight the ranges around which those asset classes may vary.

31. Risk in the context of the SIPO is the variability of return. The statement should highlight what the expected risk profile of the scheme will be as a result of the investment strategy adopted. As important as the expected risk of the scheme is the expected return. In order to make an informed decision, the employer or a scheme member should be able to ensure that the level of expected return compensates for the level of expected risk adopted by the scheme.

32. In the case of an employer sponsored scheme, the trustee should state the expected future cash inflows and outflows of the scheme in order to assist the investment manager with implementing the investment strategy. For a scheme that offers member choice, a scheme member will be able to select the appropriate choice with investment objectives appropriate to his own needs.

Regular Review of the Statement

33. At least once a year, the trustee should assess the effectiveness of the overall investment process. This would include review of the performance of the investment manager and changes in market conditions, to decide whether the investment policy statement needs to be amended.

Reporting Requirements

34. Since the investment performance of a scheme affects the accrued benefit of scheme members, they should be given a right to request for a copy of the scheme’s latest SIPO. The filing of SIPO with the MPFA would enable the Authority to monitor whether the trustee and investment manager have adhered to their stated investment policy. The statement also forms an important piece of document should problems develop in the investment of scheme assets.

Investments Practices

Investments at Arm’s Length

35. It is obvious that transactions between trustee and the investment manager with other parties should be at arm’s length so as to avoid conflict of interest. It is not uncommon, however, for an investment manager to direct transactions to a connected broker, on the ground that the connected broker providers certain advantages such as superior execution or particular expertise. Our proposals allow some flexibility while offering a reasonable degree of protection to scheme members.

Fair and Equitable Treatment in Financial Transactions

36. Our proposal of fair and equitable treatment for all MPF schemes by the trustee and investment manager is consistent with their fiduciary duties under the scheme.

Cash Commission Rebates/Soft Dollar Benefits

37. The practice in cash commission rebates/soft dollar benefits adopted for SFC authorized unit trusts and mutual funds was arrived at after substantial industry consultation. It is generally regarded as fair and practical. Should the trustee disagree with the concept of soft dollar benefits, he may prohibit such practice.

Mandatory Provident Fund Office
Financial Services Branch
24 November 1996
[Ref.: Paper/MPF/SC-9]

Last Updated on {{PUBLISH AUTO[[DATE("d mmm, yyyy")]]}}