The Securities and Futures Commission ("SFC") recently published updated FAQs in respect of the requirements applicable to a Type 1 licensed corporation or registered institution (“Type 1 custodian”) that wishes to be appointed by a private open ended fund company (“OFC”) as its custodian. If you are interested in becoming a Type 1 custodian (such as a prime broker), please contact one of our SFC Licensing or Hedge Fund lawyers.
The clarifications are helpful and further boost the attractiveness of using a private Hong Kong OFC as a hedge fund vehicle, as it is now clear that a prime broker can act as a custodian.
What documents are required for the appointment of an Type 1 custodian such as a prime broker?
For an application for the appointment of a Type 1 custodian, the documents required to be submitted in respect of the proposed custodian are set out in the SFC’s Information Checklist.
In addition to (i) duly completed and properly executed confirmations from the proposed custodian and the proposed directors, respectively regarding the proposed custodian’s internal controls and systems, and (ii) a certificate of incorporation/registration of the custodian, the applicant is required to submit documents and information to demonstrate the proposed custodian’s compliance with the eligibility requirements as set out in paragraph 7.1(b) of the OFC Code.
For a Type 1 custodian, such as a prime broker, the additional documents and information required to demonstrate compliance with the eligibility requirements will include:
(1) a copy of a valid certificate showing its licensing/registration status;
(2) the name and central entity numbers of the responsible officer(s) or executive officer(s) responsible for the overall management and supervision of its custodial function;
(3) an updated organisational chart; and
(4) where the existing systems and controls of the Type 1 custodian for the safekeeping of client assets of its Type 1 business will not be used for safekeeping of the scheme property of the OFC, a custody operational flowchart together with the reason(s) for not using such existing systems and controls for safekeeping of the scheme property of the OFC.
In respect of (3), the organisational chart is expected to include the Type 1 custodian’s organisational structure in respect of the performance of its custodial functions, which should cover, at a minimum, the name of responsible officer(s) or executive officer(s) mentioned in (2) above, the relevant reporting line, any manager-in-charge, and the teams or units involved in performing custodial functions. The SFC expects that clear references to, and descriptions of, custodial functions should be made on the chart. For example, if custodial functions are subsumed within other business units/functions of the Type 1 custodian, then this should be indicated on the chart.
In respect of (4), the custody operational flowchart of the Type 1 custodian is expected to demonstrate how its operations in safekeeping the scheme property of the OFC are in compliance with the requirements as set out in the OFC Code. This should cover, at a minimum, holding in custody all scheme property of the OFC entrusted to the Type 1 custodian which can be held with proper segregation, and maintaining proper and up-to-date records of all scheme property belonging to the OFC including any property that cannot be held in custody in the custodian’s books, with frequent reconciliations and verification of ownership of scheme property of the OFC.
For the avoidance of doubt, registered institutions (i.e. banks) registered for Type 1 regulated activity that are eligible to be appointed as private OFC custodians under 7.1(b)(i) of the OFC Code (i.e. proposed custodians which meet the same eligibility requirements as set out in the Code on Unit Trusts and Mutual Funds) are not required to submit the documents set out above for Type 1 Custodians.
Can multiple custodians be appointed for an OFC? Where multiple custodians are appointed, what would be the responsibilities of each custodian?
The Securities and Futures Ordinance ("SFO") requires that all the scheme property of an OFC must be entrusted to a custodian of the OFC for safekeeping. This does not preclude the appointment of multiple custodians.
The SFO also requires that a custodian of an OFC ensure the safe keeping of the scheme property of the OFC that is entrusted to it. Each custodian is subject to this requirement in relation to the scheme property of the OFC that is entrusted to it by the OFC.
In complying with this requirement, the custodians should also comply with the OFC Code which requires, amongst other matters, that a custodian hold in its custody the scheme property of the OFC that is entrusted to it which can be so held; and maintain a proper record of all other scheme property entrusted to it which by its nature cannot be held in custody in the account of the OFC in the custodian’s books.
In compliance with the OFC Code, Hong Kong Scheme Money (i.e. money received or held by an Type 1 custodian on behalf of a private OFC) must be paid into the segregated bank account established pursuant to the OFC Code within one business day. How does this requirement apply to subscription money?
As subscription money received and held pending the allotment of shares in the relevant private OFC is not the property of the private OFC, it is actually held on behalf of the subscribing investors until the subscription for shares in the relevant private OFC is accepted.
Custodians must therefore keep subscription money in a separate designated collection account pending the allotment of the shares in the relevant OFC. Upon acceptance of the subscription for shares in the OFC, the custodian should pay the relevant amount into the segregated bank account established pursuant to the OFC Code within one business day. Records of subscription money should be kept separately.
The OFC Code requires that a private OFC custodian keep various records, including “accounting” records. Are there examples of records that should be kept?
Under the OFC Code, a private OFC custodian is required to maintain proper and up-to-date records of all scheme property of the OFC that it receives or holds on behalf of the OFC and of all other property that cannot be held in custody. For example, the records should enable all movements of the scheme property to be traced through the private OFC custodian’s systems with frequent reconciliations.
Records should also be kept which are sufficient to show particulars of the liabilities, including any financial commitments and contingent liabilities of a private OFC. This would likely include but is not limited to the keeping of records of items such as holdings, transaction settlement status, corporate actions, cash balances, accrued fees, receivables, and payables to facilitate the private OFC custodian in reconciling the existence of certain scheme property specified in the OFC Code.