Circular to Management Companies and Trustees/Custodians of SFC-authorized Funds - Relating to Fair Valuation of Fund Assets

Revised as of 17 December 2018

Introduction

1. The purpose of this circular is to provide guidance to management companies of SFC-authorized funds (the Managers) on the valuation policies and procedures of SFC-authorized funds (the funds), particularly where the market value of a fund asset is unavailable or unreliable or becomes illiquid or hard-to-value as a result of significant market events.  This circular is applicable to valuation of all types of assets of a fund including equities, fixed income and other investments.

2. The trustees and custodians of funds are reminded of their duty regarding valuation of the funds and should have due regard to the guidance set out in this circular in discharging their duties to investors of the funds.

   General principles 

3. Proper valuation of fund assets is critical to ensure investor confidence in funds as a reliable and robust investment vehicle, and for proper investor protection.

4. As part of its duties, the Manager should at all times exercise due care, skill and diligence to ensure that:

   - all assets of a fund are fairly and accurately valued in good faith and in the best interests of investors;

   - the net asset value (NAV) of the fund is correctly calculated, in accordance with the constitutive and offering documents of the fund and applicable laws and regulations;

   - incoming, continuing and outgoing investors should be treated fairly such that subscriptions and redemptions of fund units are effected in a non-discriminatory manner; and

   - the assets of the fund are consistently valued according to fund’s valuation policies and procedures. 

5. The Manager should establish comprehensive, documented policies and procedures to govern the valuation of assets of a fund.  Such policies and procedures should identify appropriate valuation methodologies that will be used for valuing each type of asset of the fund, having due regard to the nature of the asset type as well as market and industry best practices (including applicable IOSCO principles¹).  In choosing a valuation method, the Manager should, where appropriate, consult the trustee or custodian of the fund and seek advice from a suitably qualified third party expert, such as a reputable pricing agent.

6. A fund’s valuation policies and procedures, and any material change thereto, should be appropriately disclosed to investors in the fund’s offering documents. 

   Fair valuation of assets

7. Assets of a fund should be valued according to current market prices provided that those prices are available, reliable and frequently updated based on transactions in an active market.

8. We note that it is funds industry’s general practice that under normal market conditions:  

   - closing market values or last traded prices are used for valuing listed equity securities; and

   - reported prices and quotations with price adjustments considered by the Manager having regard to market activity and conditions including supplemental pricing information are used for valuing fixed income investments. 

9. However, where the market value of an asset is unavailable or where the Manager reasonably believes that no reliable price exists or the most recent price available does not reflect a price the fund would expect to receive upon the current sale of the asset, the Manager should value the asset at a price which reflects a fair and reasonable price for that asset in the prevailing circumstances (the fair value price / fair value adjustment).

10. The Manager should establish comprehensive policies and procedures in relation to the use of the fair value price for valuing assets of a fund, including the following:
    

    - the circumstances which may give rise to the use of the fair value price, e.g. suspension of trading of a listed stock, there is no recent trade in the security concerned or an asset becomes illiquid for any reason, the occurrence of a significant event since the most recent closure of the market where the price of the security is taken;

    - the considerations and factors to be taken into account as to whether and how fair value adjustment should be made, e.g. the type of asset involved, the size of the asset owned by the fund and potential impact on the NAV of the fund, the method or basis to be used and reliability of the alternative price used;

    - the process for handling and documenting events leading to triggering the use of fair value price; and

    - the governance structure and review process for fair value adjustment (including any decision to use or not to use fair value price) e.g. the establishment of pricing committee or review by senior management of the Manager of the actions and decision taken. 
    

11. The process and conduct of fair value adjustment (including any decision to use or not to use fair value price) should be done by the Manager with due care, skill and diligence and in good faith, in consultation with the trustee or custodian of the fund.

12. The valuation method, the implementation plan and underlying rationale should be clearly documented and subject to appropriate review and approval by a pricing committee or senior management of the Manager, in order to ensure that any conflicts of interest are appropriately identified and mitigated.

13. Senior management of the Manager of a fund should constantly review the fair value adjustment policies and procedures to ensure their continued appropriateness and effective implementation, particularly where there are material changes in circumstances and market conditions which may affect the fund or its investments.
    
    Further points to note

14. We understand that Managers may have different fair value adjustment policies and may adopt different valuation methodologies for different reasons.  Please note that the SFC in general does not prescribe any single approach or method in a particular situation, subject to the Manager’s compliance with their duties (including the principles and guidance given in this circular) in ensuring the fund’s assets being fairly and accurately valued.

15. The valuation of assets of a fund is critical to investors because it affects, among other things, the fund’s NAV, financial reporting, performance reporting and presentation, and fees paid to the fund’s service providers (including the Manager).  As such, in general, we do not consider that there being no or only very few subscription or redemption orders received by a fund is in itself a valid reason for the Manager not to undertake a fair valuation adjustment  where the circumstances referred to in paragraph 9 above exist.
    
    Suspension of dealings and fair valuation

16. The SFC generally expects that the Manager should carefully consider suspension of valuation and dealings in the units of a fund where the market value or fair value of a material portion of the fund’s assets cannot be determined, in consultation with the trustee or custodian of the fund, in the exclusive interest of investors in the fund.²

17. In market stress scenarios, where a fund has not suspended redemptions of units in the fund, the fair valuation of the fund’s assets is of utmost importance and it is incumbent on the Manager to ensure fair valuation is done having due regard to the interests of incoming, remaining and outgoing investors.

Investment Products Division

Securities and Futures Commission

¹ For examples, Principle 27 of the IOSCO Objectives and Principles of Securities Regulation, IOSCO Report, June 2010 and Principles for the Valuation of Collective Investment Schemes, Final Report of the Board of IOSCO, May 2013.

² Managers are also urged to take note of their obligations and the applicable requirements as set out in the circular to management companies of SFC-authorized funds on liquidity risk management dated 4 July 2016.  [Amended]