Report of the Survey on Fund Trading Practices (Market Timing, Late Trading and Selective Disclosure)

The SFC today releases the Report of the Survey on Fund Trading Practices. It is the first published report on findings about market timing and late trading issued by a securities regulator in the Asian region.

The Survey was conducted in the first quarter of 2004 with a view to collecting general information about market timing (Note 1), late trading and selective disclosure of non-public information by fund managers operating in Hong Kong during the period between January 2002 and December 2003. The Survey is focused on finding out the extent to which funds managed/advised by SFC licensed fund managers/advisers may be subject to market timers’ activities. The Survey forms part of the SFC’s overall regulatory efforts to examine current market practices in relation to fund management.

Licensed corporations that carry out fund management or fund advisory business in Hong Kong were invited to respond to a questionnaire designed to solicit general information in the above three key areas of trading practices (Note 2).

Background Data

The Survey shows that 86 licensed corporations carried on fund management businesses relating to open-ended funds during the period. Since open-ended funds allow subscriptions and redemptions by investors at regular intervals, information on how these 86 firms implemented policies on late trading and selective disclosure of portfolio holdings was analysed and included in these findings.

Also, the Survey notes that among the 86 firms, only 48 of them manage or advise on funds that invest in global securities (Selected Firms). In view of the timing differences between the closing of various markets for the underlying securities, global securities funds managed/advised by the Selected Firms were considered to be open to abuses by market timers for the purpose of the Survey. Accordingly, the findings in relation to market timing activities and preventive measures for such activities were based on information gathered from the Selected Firms.

Market timing, late trading and selective disclosure of non-public information by fund managers have attracted attention at the international fund industry level. While market timing is not illegal, the conduct of market timing in conjunction with other practices such as trading on non-public information and exploiting time arbitrage by way of late trading, may act to the detriment of long-term investors in a fund.

Key Findings

Market timing -- Market timing may dilute the long-term interests of investors in a mutual fund. For example, a mutual fund’s investment adviser may maintain a larger percentage of its assets in cash or may be forced to liquidate certain portfolio securities prematurely to meet higher levels of redemptions due to market timing. Mutual funds also may incur increased brokerage and administrative costs related to the frequent purchases and redemptions associated with market timing.

The Survey does not find market timing a widespread phenomenon in the Hong Kong market. Of the Selected Firms, 24 of them, representing 90% of the total AUM (Assets Under Management) managed by all Selected Firms, have established formal monitoring systems for market timing. However, there were two instances where market timers had made approaches to Hong Kong retail fund managers to explore possible market timing opportunities. Most well-established fund managers in Hong Kong maintained a certain degree of surveillance over market timing activities although the preventive measures they adopted vary according to their internal policies and modes of operations.

Late trading – Late trading arises where a fund is adopting forward pricing, and its fund manager allows an investor to subscribe or redeem the fund’s units after the fund’s valuation. By providing this late trading privilege, market timers may be able to benefit from transacting at a known fund price.

According to the Survey, late trading does not appear to be prevalent in Hong Kong as nearly all respondent firms confirmed that they strictly adhered to the collection deadlines for subscriptions/redemption orders. Those firms that had allowed deviations from their collection deadlines on certain occasions attributed these to administrative reasons such as failure of transmission or IT systems of distributors or investors. However, these firms were still able to maintain that such orders received could be processed on a forward pricing basis.

Selective disclosure -- The Survey also reveals that there were no unified policies adopted by the fund industry to deal with selective disclosure of non-public information relating to a fund’s portfolio. Some fund managers imposed a policy to ban outright selective disclosure while others might, in restricted circumstances, selectively disclose a fund’s holdings upon client’s requests.

Mrs Alexa Lam, SFC’s Executive Director of Intermediaries and Investment Products, said: "The Survey reveals that our market is not immune to approaches by market timers who wish to exploit arbitrage opportunities through market timing and late trading activities, and that local fund managers are aware of the issues relating to market timing and late trading."

"Fund managers should exercise vigilance in detecting and preventing possible abusive practices and are expected to put in place effective risk control measures to safeguard investors’ interests. The SFC encourages fund managers to report to us any irregular market activities suspected in the course of their fund management operations," Mrs Lam said.

"We believe that investors’ confidence is key to the sustainable growth of the Hong Kong fund industry. The SFC is committed to working with our fund managers to ensure that the industry serves its investors in a fair and efficient manner. We will examine the issues covered in the Survey, perform further review of the fund trading practices and discuss with the industry to work out possible means to guard against abusive trading practices. Given that Hong Kong is a key fund management centre for both local and international funds, we will work together and share information with other securities regulators in leading fund management centres in this and other aspects of fund management regulation," Mrs Lam added.

A copy of the Report of the Survey on Fund Trading Practices is attached to this press release and available on the SFC website under "Press Releases, Publications and Speeches" - "Publications" - "Surveys and Reports".

Ends

Notes to Editors:

1. While "market timing" is not a precisely defined term, it generally refers to a trading strategy involving the frequent buying and selling of units/shares in open-ended funds in order to take advantage of a time lag between a change in the value of a fund’s portfolio securities and the reflection of the change in the fund price.

2. The questionnaire was sent to 176 licensed corporations that carry on fund management or advisory businesses in Hong Kong.