The COVID-19 pandemic has caused significant disruptions to numerous industries and sectors on a worldwide scale in an unprecedented manner. The asset management industry, like so many other business sectors, has proven far from immune to the impact of the health crisis. This alert aims to provide an overview of several key items that Hong Kong-based fund managers and financial markets participants with an office in or exposure to Hong Kong or Asia may wish to take into consideration as they navigate the challenges presented by this outbreak.

Provisions in Fund Documents and Regulatory Obligations Impacting Liquidity and Related Internal Liquidity Risk Management Policies

Gating/Suspensions/Side Pockets

Our clients should ensure that they are familiar with the following provisions of their fund documents:

  • The types of assets your funds are invested in will dictate the types of stress your fund is experiencing right now. You should be familiar with the gating and suspension criteria in your fund documents and the likelihood of this criteria applying to your current circumstances.
  • In what circumstances can you impose a redemption gate and how do these provisions operate?
  • Do your documents provide for an investor level gate or does it apply at the feeder fund/master fund level?
  • You should also ensure that you are familiar with any obligations that might exist to notify regulators of suspensions or the creation of redemption gates and your notification obligations to investors.
  • You should familiarize yourself with your ability to side pocket assets pursuant to your documents and the regulatory requirements that exist around doing so both in the domicile of your fund and in accordance with the regulations that the fund © 2020 Akin Gump Strauss Hauer & Feld LLP 2 management company is subject to (for example, the Fund Manager Code of Conduct (FMCC) in Hong Kong).
  • The Securities and Future Commission (SFC) in Hong Kong has issued several circulars regarding liquidity risk management in recent years. The FMCC dictates at Section 3.14 various onerous requirements relating to liquidity risk management. It is important that Hong Kong asset managers adhere to these responsibilities.
  • If your organization manages authorized funds, it will also be subject to the Circular to Management Companies of SFC-Authorized Funds on Liquidity Risk Management issued by the SFC in July 2016. Authorized funds should also be aware of their obligations to notify the SFC of significant redemptions.

Margin Calls/Haircuts/Netting Off of Exposure

Many prime brokerage agreements and ISDA Master Agreements contain termination provisions that permit a prime broker to close out all outstanding trades with a fund counterparty and to net off their exposure to such counterparty in the event that the net asset value of the fund goes below a certain level. Where funds have borrowed against securities that they hold they may now be facing margin calls as the value of these securities decline.

In addition, prime brokers and other counterparties may decide to be more stringent regarding the types of securities they will accept as collateral given that such securities may be becoming illiquid or hard to value or the spreads on such assets are widening. Prime brokers may be applying significantly larger haircuts to collateral.

You should assess whether any of the events of default or termination events as those terms are defined in your prime brokerage agreements and ISDA Master Agreements are likely to be triggered and communicate with your prime broker to try to address these issues before they become a problem.

Valuation Issues

With the market going into distress, assets may become illiquid, spreads may widen and your fund's existing valuation policies may not be appropriate in all respects. You should carefully review the valuation policies set out in fund documents together with any related internal policies.

If investments can no longer be properly valued in accordance with the fund's established valuation rules, the investment manager or fund directors may need to deviate from the fund's established valuation methodologies or resort to price overrides as permitted by the fund documents.

SFC Type 9 licensed fund managers must ensure that they handle any price deviation or override in compliance with the Fund Manager Code of Conduct. The fund manager will need to ensure that the reason for the price deviation or override is documented, providing a description of the method used to determine the appropriate price and ensure that a functionally independent party (e.g., the fund's auditor) performs a review of the price deviation or override.

Problems Faced by Private Equity Fund Managers

Private equity fund managers may find that they need to deal with defaulting limited partners whose liquidity position is such that they are unable to honor capital calls that they have committed to. It is important that such managers and the directors (or alternative governing bodies) of the general partner of the relevant funds are fully familiar with the provisions of the limited partnership agreement governing defaults and are aware of what steps may be taken to penalize such limited partners and of any flexibility that might apply in applying such provisions. Proper consideration will need to be given to the interests of all of the limited partners in the fund. Private equity fund managers and the directors of the general partner of such funds should also be aware of the circumstances in which a limited partner may be excused from honoring a capital call and the conditions that such limited partner needs to fulfil in order to be excused.

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The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.