China-focused funds in Hong Kong are adopting measures to improve how they cope with liquidity shocks from Chinese markets after the securities regulator found some investors were unfairly treated during last year’s market rout.
More than half of the mainland’s listed firms suspended trading in their stocks at the height of the slump in July, which made it hard for fund managers to value their portfolios and meet a flood of redemptions from investors eager to cut their losses.
Fund managers are once again on notice of potential redemptions. After a brief respite from last year’s fall, Chinese stocks so far in 2016 have dropped about 25 percent, wiping off 13 trillion yuan (USD2 trillion) in market capitalization.
Inspections by the Securities and Futures Commission (SFC) kicked off last year found many funds did not have rigorous processes for valuing their portfolios in the extreme conditions, people with knowledge of the discussions between the regulator and industry said.
“This meant some investors were able to redeem at a higher price than they should have, leaving those left in the fund with a lower price. This is raising alarm bells,” said Stewart Aldcroft, chief executive of CitiTrust, which acts as a trustee to several Hong Kong funds and has been involved in industry discussions on the matter.
Following the inspections and faced with waning investor confidence, hedge funds, asset managers and exchange traded funds now hold more cash, so it is easier to meet redemption requests at times of stress.
Asset managers, including Allianz Global Investors and BNP Paribas Investment Partners, are increasing their use of the stock connect scheme, a trading mechanism that allows funds in Hong Kong to adjust positions in Shanghai’s stock markets more rapidly than using China’s other investment channels.
Some funds are also introducing stricter policies on valuing stocks that have halted trading and on managing redemptions.
Chinese stocks dropped around 40 percent in just a few months last year, prompting investors to rush for the exits. An unexpected devaluation of the yuan in August added to concerns that the economy was in worse shape than policymakers had let on.
The SFC found that during the slump many funds did not have an orderly process for handling redemptions. They chose not to use measures that could have alleviated liquidity stress, such as capping daily redemptions or suspending them altogether, fearing such action would damage their reputation.
This meant investors left at the back of the redemption queue, or who did not redeem their investments at all, were sometimes left holding illiquid stocks – a situation the SFC believes may constitute unfair treatment, fund managers said.
“Suspension of trading in a fund when a certain amount of underlying stocks are halted and better market liquidity are necessary to boost investor confidence,” said Tobias Bland, chief executive of asset management firm Enhanced Investment Products in Hong Kong.
The SFC is expected to make a second round of inspections and issue new guidelines in coming months, industry participants said. An SFC spokesman said the regulator had maintained “close dialogue” with asset managers, but he did not elaborate on the outcome of the inspections.
“Management companies are required to have procedures to handle issues related to redemption, subscription and valuation of fund assets to ensure all investors are treated fairly, and they should keep investors informed of such procedures,” he said.
China’s yuan-denominated stock markets are the third riskiest in the world after Egypt and Greece, risk management firm Axioma says.
“Liquidity risk management is one of the key concerns for fund managers,” said Caroline Yu Maurer, head of Greater China equities for BNP Paribas Investment Partners in Hong Kong. “What if I have big redemptions but I can’t sell the stocks?”
Words: Reuters
