The Securities and Futures Commission (SFC) recently updated its Frequently Asked Questions relating to Open-ended Fund Companies (FAQ) to emphasize and provide clarity on rules governing third party payments and receipts for custodians (Private OFC Custodian) of private open-ended fund companies (Private OFC).
The SFC’s emphasis and clarifications comes as an expected move considering various concerns and approaches raised amongst industry service providers, Private OFC Custodians and fund managers when dealing with payments, receipts and cash accounts of Private OFCs.
Applicable laws and regulations
Under the requirements of the Securities and Futures Ordinance, all scheme property of an OFC must be entrusted to a custodian for safe keeping, the appointment of which is subject to the approval of the SFC. Under the current regime, to quality as a Private OFC Custodian, the entity must meet one of two criteria: (1) fulfill the same eligibility requirements as custodians for SFC-authorised funds under the Code on Unit Trusts and Mutual Funds, or (2) be a licensed corporation or registered institution (Type 1 regulated activity) that meets the specific criteria set out in Chapter 7 of the Code on Open-Ended Fund Companies.
Third-party payments and custodian due diligence
A Private OFC Custodian is engaged to hold in custody, scheme property of a Private OFC, including securities and cash of the Private OFC which may be in turn used to settle expenses of the Private OFC as well as to pay distributions and redemption proceeds to investors of the Private OFC.
In fulfilling the duties of a Private OFC Custodian, the SFC has through the FAQ clarified that Private OFC Custodians are not prohibited from processing third-party payments or receipts on behalf of a Private OFC, provided they conduct a thorough due diligence process to ensure compliance with the Guideline on Anti-Money Laundering and Counter-Financing of Terrorism (applicable to Licensed Corporations and SFC-licensed Virtual Asset Service Providers). Accordingly, Private OFC Custodians are permitted to make direct payments to investors and/or service providers of an OFC, including on a standing approval basis, notwithstanding that the Private OFC Custodian’s client on record is the Private OFC.
Custody of Monies
Through the recent FAQ, the SFC also reiterated that cash monies which form part of the scheme property of a Private OFC, must be entrusted to the approved Private OFC Custodian and such Private OFC Custodian must maintain a segregated client bank account for such safekeeping.
Takeaways and Practical Implications
The SFC’s update to the FAQ is a clarification and reiteration of their interpretation of the current regulatory regime dealing with custody arrangements for Private OFCs and third party payments and receipts. In light of the clarification, Private OFC Custodians may wish to revisit their internal policies dealing with third party payments and receipts.
Importantly, fund managers may need to ensure that the Private OFCs they manage are in full compliance with the custody requirements and/or may consider the possibility of streamlining and simplifying custody arrangements with an aim to achieve cost savings.
