High-risk Cayman hedge funds slip past regulator’s scrutiny in Hong Kong

Thursday, April 8, 2004

According to The Standard, millions of dollars-worth of Cayman-registered hedge funds are being sold in Hong Kong, even though most are not authorised or scrutinised by the Hong Kong Securities and Futures Commission (SFC).

Among those buying the risky products are retail customers who are unaware they are not supposed to be marketed the risk-heavy, highly leveraged financial instruments.

Driving this gray market activity are investment advisers and private bankers eager to collect an assortment of management and performance fees for placing their customers in alternative financial products.

Making hedge funds exceptionally attractive to financial intermediaries is leverage, which multiplies the amount of investment on which commissions can be placed.

The collapse and liquidation of two Cayman-registered, Hong Kong-linked hedge funds Global Diversified Trading (GDT) and Global Opportunities Trading (GOT) has underscored the dangers of retail hedge-fund investment. Hundreds of shareholders, many retail investors from Hong Kong, have lost an estimated US$50 million.

Most shareholders were sold their investment by Towry Law (Asia) HK, part of the UK-based financial planning firm, which allegedly collected hefty fees for directing clients into the funds.

Liquidators to the GDT fund have pointed to the likelihood the two funds were part of a wide-ranging share price-ramping fraud involving a handful of thinly traded Hong Kong securities and warrants.

SFC officials have reportedly declined to be interviewed. In statements to The Standard, an SFC spokesman said the regulator “is investigating areas that fall under SFC jurisdiction and is in close co-operation with CCB (Commercial Crimes Bureau).’

The Standard reports that the SFC has been reluctant to investigate the funds or how they were managed and promoted. In the 18 months since GDT and GOT stopped trading and went into voluntary liquidation, the SFC has not disciplined or prosecuted anyone involved with the schemes.

This, despite the regulator’s knowledge that GDT was engaged in suspicious trading activity as early as June 2000. Part of the reason appears to be jurisdiction: The two Cayman Islands funds never applied for authorisation in Hong Kong.

The spokesman said people and businesses selling and managing hedge funds may be held accountable to the Securities and Futures Ordinance and Code of Conduct rules.

The SFC “welcomes any information on suspected breaches of the law and other relevant codes or guidelines. We will not hesitate in taking enforcement action against those who are in breach of them," he said.

But the SFC was unable to produce an example where a financial intermediary has been disciplined or prosecuted by the regulator for mismanaging or promoting unauthorised funds.

Hong Kong’s hedge-fund market represents a small part of the city’s registered fund management industry. Only 10 hedge funds have been authorised by the SFC for retail marketing, and at the end of last year their net asset value amounted to less than US$1 billion (HK$7.8 billion).
By comparison, Hong Kong has authorised 1,873 unit trusts and mutual funds, representing net asset value at the end of last year of US$525 billion.

Hong Kong is also home to another 67 unauthorised hedge funds, according to Eurekahedge, the Asian hedge-fund consultancy. These offshore funds manage an estimated US$5.4 billion in assets.

Eurekahedge believes that authorised and unauthorised hedge funds have raised US$2.73 billion in Hong Kong since the start of 2001.

Hedge funds are mostly organised as private partnerships, located offshore for tax and regulatory reasons, with few restrictions and reporting requirements placed on fund managers, who use short-selling and leverage and, often, derivative financial instruments in their strategies.

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