PLC Sub-Committee on Subsidiary Legislation of the MPF System
Information Note
Investment Management
Purpose
This paper describes the proposed requirements on the investment management of MPF funds -
- investment arrangement (paragraphs 2 to 4);
- control and supervision of investment manager (paragraphs 5 to 10);
- statement of investment policy (paragraphs 11 to 13); and
- investment practices (paragraphs 14 to 17).
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 Strategy
3.We propose that the trustee could adopt a " passive investment strategy " by using approved pooled investment funds. The investment portfolio of an approved pooled investment fund should be managed by -
- a qualified investment manager; or
- an authorized insurer that is a registered (rather than exempted) investment adviser with the SFC, in the case of retirement scheme policies issued by the insurer.
A Combination of Investment Strategies
4.We propose that the trustee could adopt a combination of the investment strategies stated in paragraphs 2 and 3 above.
[Note : an MPF fund refers to an approved pooled investment fund or an MPF scheme, or in the case of a scheme with member's choice, each member choice fund.]
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 and the trustee/custodian are both subsidiaries of a substantial financial institution or a holding company of a substantial financial institution, they are deemed to be independent of each other if -
- neither one of them is a subsidiary of the other;
- no person is a director of both entities; and
- both entities sign an undertaking that they will act independently of each other in their dealings with the fund.
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 -
- no conflict of interest with other service providers of the fund;
- proper staff and resources to carry out investment management; and
- 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 assets of the fund to an associated investment management company which is -
- registered with the SFC; or
- subject to an " acceptable supervisory regime " in its country of establishment as construed by the SFC (i.e. SEC of the US and IMRO of the UK).
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 -
- provisions of the Client Agreement under section 6 of the SFC's Code of Conduct for Persons Registered with the SFC;
- provisions to enable the trustee to require the investment manager from time to time to provide -
- appropriate information as to the making of, and return, on the investments; and
- such information as is necessary to enable the trustee to assess the capability of the investment manager to manage the investments of the fund;
- whether the agreement precludes any other agreements that any of the contracting parties may have or intend to have;
- what period of notice to be given by either party to terminate the contract;
- that the agreement to 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 in respect of a voluntary winding up; and
- 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 fund. 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 -
- any relationship that the investment manager has with other service providers of the MPF fund that are its associates; and
- any arrangement where fees, commissions or other payments are received from, paid to or shared with a third party or service provider as a result the appointment of the investment manager for the MPF fund, and disclose the amount of such sums.
Statement of Investment Policy
Content of the Statement
11.For each MPF fund, we propose that the trustee should formulate a statement of investment policy which forms part of the investment management agreement with the investment manager. The statement should include
- primary investment objective of the fund;
- policy concerning -
- the kinds of investments held; and
- the balance between different kinds of investments;
- risk of the investment strategy of the overall portfolio;
- expected returns of the overall portfolio; and
Regular Review of the Statement
12.We propose that the statement be reviewed by the trustee at least once a year and confirmed or amended.
Reporting Requirements
13.We propose that the statement should form part of registration documents and the annual report to the MPFA. The trustee should also make it available to 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 fund than those which it is reasonably expected from parties dealing at arm's length.
15.Furthermore, the investment manager's dealing with associated stock brokers, banks or other market makers should in aggregate not exceed 50% of the value of the transactions in a year. All brokerage and commissions with such associates should be disclosed to the trustee.
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 funds 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 should be adopted where soft dollar benefits are explicitly permitted under the investment management agreement and the trustee may at his discretion prohibit soft dollar arrangements.
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 fund. Local presence also facilitates communication.
Passive Investment Strategy
19.Our proposals would permit trustees to select " off-the-self " pooled investment funds, however, these funds should comply fully with MPF investment restrictions and guidelines and are managed by qualified investment managers meeting MPF requirements. An authorized insurer may self-manage its statutory fund if it has the expertise and subject to SFC regulation of its investment conduct.
A combination of investment strategies
20.The proposal in paragraph 4 above will provide 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 restrictions and guidelines.
Trustee's 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 fund is a kind of collective investment scheme and thus should subject to this separation of function providing the necessary checks and balance 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 manager 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 MPF fund 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 MPF fund, 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 reactions for the benefit of fund 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 Policy
Content of the Statement
28.The statement of investment policy is a standard requirement in many developed countries' (such as Australia, Canada and the UK) pension legislation. The requirement for a statement of investment policy will force the trustee to make clear the investment policy and objectives of an MPF fund and provides guidance to the investment manager. In making investment decisions, the investment manager would have to consider whether they are consistent with the statement of investment policy. 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 overall objective of an MPF fund. 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 kinds of investments held will detail the various types of asset classes in which the MPF fund will invest and what restrictions may be imposed in addition to MPF investment restrictions and guidelines; whether the fund will use derivatives and to what extent; whether the fund will participate in the practice of securities 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 statement of investment policy is the variability of return. The statement should highlight what the expected risk profile of the MPF fund will be as a result of the investment strategy adopted. As important as the expected risk of the fund is the expected return. In order to make an informed decision, the employer or a member of the fund should be able to consider that the level of expected return compensates for the level of expected risk adopted by the fund.
32.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 condition, to decide whether the investment policy statement needs to be amended.
Reporting Requirements
34.Since the investment performance of an MPF fund affects the accrued benefit of members of the fund, they should be given a right to request for a copy of the fund's latest statement of investment policy. The filing of statement of investment policy with the MPFA would enable the Authority to monitor whether the trustee and investment manager have adhere to their stated investment policy. The statement also forms an important piece of document should problems develop in the investment of fund assets.
Investments Practices
Investments at Arm's Length
35.It is obvious that transactions between the 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 an associated broker, on the ground that the associated broker providers certain advantages such as superior execution or particular expertise. Our proposals allow some flexibility while offering a reasonable degree of protection to members of an MPF fund.
Fair and Equitable Treatment in Financial Transactions
36.Our proposal of fair and equitable treatment for all MPF funds by the trustee and the investment manager is consistent with their fiduciary duties under the MPF fund.
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 Bureau
13 November 1997
