chinese meltdown fund managers take cover behind legalese 1435242015

Fund documentation being tweaked as regulatory risks escalate in Chinese markets

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By :  ,  Financial Analyst

Fund managers at hedge funds, asset management companies and ETF’s are adding new legal language to their fund documentation in respect of Chinese investment products to safeguard themselves, as well as investors, from newfound Chinese investment risks.

These risks, which emerged in the recent market meltdown, include heavy-handed government intervention, trading halts, liquidity freezes, short-selling bans and other regulatory restrictions. "Since the crisis, we have seen a general recalibration of China risk across the fund management industry, with regulatory risk now seen as much higher," said Effie Vasilopoulos, a partner at law firm Sidley Austin in Hong Kong, according to the Business Times.

Disclosure of these risks, which can significantly impinge on fund operation and returns, is now being built into fund documentation by the managers in a bid to protect investors who may be holding the bag in the event such market events unfold.

In July, when Chinese stocks entered their free fall, over half of the companies listed on the mainland Chinese exchanges halted trading in their stocks. Result: hapless fund managers could neither bail positions, nor even value their funds appropriately.

According to a Reuters report, BlackRock, Inc.(NYSE:BLK), recently modified the legal documents for its US$5.1 billion iShares FTSE A50 China Index ETF – adding clauses to the fund prospectus that warned investors of various kinds of risks from “market disruption events.”

"The government's actions have shown their lack of confidence in the market mechanism and its ability to achieve stable levels reasonably swiftly," said Sanjiv Shah, chief investment officer at London-based Sun Global Investments, a fund manager for high net worth clients. "This further damages the confidence of existing and prospective investors."

Funds invested in China have been predominantly long-oriented, and have paid a stiff price in the sell-off. Unfortunately, government restrictions that control the ‘who, how, and how much’ of trading have severely limited the options for these funds in the event of severe market volatility. Even funds that would have liked to hedge their long bets were restricted by these stifling regulations.

According to a September Business Insider report, daily traded volumes in China’s CSI 300 and 500 futures have fallen 99 per cent in the space of just three months. This makes for a very thin market that funds would find difficult to trade in, particularly in a fearful environment when investors are piling on redemption notices.

"We are very busy updating risk disclosures across all types of China products at the moment, and we expect to stay busy on this until the end of the year," said Vasilopoulos to Reuters.

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