Issuers Add Warnings To China Funds

Government intervention in the Chinese stock markets seen as material risk.

Reviewed by: Michelle Price
Edited by: Michelle Price

Hong Kong (Reuters) Fund managers are adding new warnings to China investment products in a bid to reduce their legal liability if regulators repeat the heavy-handed intervention in financial markets that rattled investors globally.

Hedge funds, asset managers and exchange-traded fund providers are scrambling to add the new disclosures to legal fund documents following watershed government actions in recent months that are now forcing managers to rethink China investment risk.

The legal measures illustrate the degree to which China's market intervention is set to have a tangible long-term impact on investor confidence. Rather than shrugging off the actions of the government, fund managers see the intervention as a material risk going forward, lawyers and fund managers said.

Intervention Damages Credibility
"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, which manages money for high net worth clients. "This further damages the confidence of existing and prospective investors."

The disclosures on trading halts, liquidity freezes, short-selling bans and other regulatory restrictions could see retail investors, pension funds and insurers pull more money out of these products in coming months.

Exchange filings show BlackRock Inc., the world's biggest asset manager, updated the legal documents for some of its [funds] in August and September. The updates added swaths of new language on the potential risks and costs of a "market disruption event" such as share suspensions or other actions that freeze market liquidity and so could leave investors out of pocket.

‘Liquidity Risk’ Warnings
Likewise, New York-headquartered KraneShares last month added a new "liquidity risk" warning to its China A-share ETF prospectus as well as tweaks to its strategy, regulatory filings show.

Brendan Ahern, chief investment officer of KraneShares, said the changes allow the portfolio manager greater "flexibility" amid extensive trading halts.

China unleashed a volley of measures to try to prop up share prices that have slumped around 40 percent since the middle of June. These included pushing domestic investors, including banks and brokerages, to buy shares, imposing caps on selling stocks and restrictions on futures trading.

At the height of the crisis in July, more than half of all mainland-listed companies halted trading in their stocks, leaving fund managers unable to value their funds or liquidate their positions.

Obligated To Highlight Material Risks
These interventions are now seen as material risks that asset managers are legally obliged to highlight, or else risk hefty costs or potential lawsuits.

"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 Effie Vasilopoulos, a partner at law firm Sidley Austin in Hong Kong. "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."

China has insisted it is on the path of economic and financial reform. Just last week, Chinese President Xi Jinping was quoted as saying the intervention had been necessary to "defuse systemic risks."

To be sure, regulatory requirements meant that the majority of China fund prospectuses contained a range of risk warnings prior to the summer turmoil.

More Extensive Warnings
But many new prospectuses are including more extensive and detailed disclosures on the risk of broader government action that could impede a manager's ability to value the fund and make redemption payments.

When Hong Kong's GF International Investment Management launched a new China fund in late July, for example, the prospectus featured a novel risk category: "Government Intervention and Restriction," filings show. GF International did not immediately respond to requests for comment.

"The risks of government intervention have increased, and this will make investors more cautious in the short to medium term," said Shah if Sun Global Investments, which invests in Chinese companies and yuan bonds.

More Power For Fund Managers
These new disclosures generally aim to give managers greater power to respond to market events, suspend fund redemptions or to pass costs created by a liquidity freeze on to investors.

"The contents of the prospectuses is pretty crucial in these circumstances. If investors aren't made aware of these potential costs, they can become very aggrieved," said a lawyer, who declined to be identified because of the sensitivity of the issue.

The disclosures could make it difficult for retail investors or funds of funds that generally require high levels of liquidity to invest in China equities on the same basis as before, said Vasilopoulos. "If it's a dedicated China strategy, that could have a lasting impact on the fund, although we may only start to see the real effects of this in the last quarter."