Private Funds: A Perspective from Malaysia

1.   Introduction

According to the 2021 Annual Report of Securities Commission Malaysia (“SC”), despite the challenging environment faced by the Malaysian economy due to Covid-19, the wholesale funds industry recorded a total net asset value of RM79.45 billion at end-2021, an increase of 17.44% from RM67.65 billion in 2020. 

A “wholesale fund” is defined under the Guidelines on Unlisted Capital Market Products under the Lodge and Launch Framework (“LOLA Guidelines”) as a unit trust scheme established where the units are to be issued, offered for subscription or purchase, or for which invitations to subscribe for or purchase the units are to be made, exclusively to sophisticated investors and any other person as may be determined by SC. As of 31 May 2022, there are 430 wholesale funds lodged with the SC.[1] “Sophisticated investors” means accredited investors, high-net worth entities or high-net worth individuals as defined under the Capital Markets and Services Act 2007 (“CMSA”). A fund of such nature may be generally known as private funds in other jurisdictions.

There are different types of wholesale funds in Malaysia, namely local wholesale funds, foreign wholesale funds, Islamic local wholesale funds and Islamic foreign wholesale funds. We will focus our discussion on local wholesale funds in this article. 

2.    Fund Management Company

As prescribed under Sections 288(2) and 289(1) of the CMSA, only a management company approved by the SC can act as a fund management company. A fund management company must comply with, amongst others, the following criteria:

• be an entity incorporated in Malaysia; and
• always have at least RM10 million of shareholders’ funds.

3.    Establishment of a Wholesale Fund

The LOLA Guidelines set out the requirements to be complied with by any person intending to establish a wholesale fund in Malaysia. A local wholesale fund can only be established by a fund management company holding a Capital Markets Services Licence for the regulated activity of fund management in relation to portfolio management.

A wholesale fund can be formed either under a trust structure or a custodial structure.

When establishing a wholesale fund, the fund management company or the operator of the fund must, amongst others:

•  ascertain the size of the wholesale fund, investment objectives, financial situation and particular needs of its investors;
• take into account its resources, expertise, experience and its overall capability to carry out its duties in accordance with the acceptable and efficacious business practices within the fund management industry;
• ensure that the name given to the wholesale fund is not inappropriate, misleading or in conflict with the name of another collective investment scheme (“CIS”);
• determine the investment objective of the wholesale fund;
• define the investment strategy of the wholesale fund including the investment parameters and types of investments to be made by the wholesale fund; and
• ensure that the liabilities of investors are limited to their investments in the wholesale fund.

The fund management company or the operator is permitted to allocate capital into one or more collective investment schemes (referred to as “target fund”), provided that the selection of the target fund is consistent with the investment objective and chosen strategy of the wholesale fund.

The fund management company or the operator must also ensure that the investments of the wholesale fund must not be detrimental to the interest of the investors or contrary to public interests. Further, the nature and structure of the wholesale fund’s investments must not result in the circumvention of any regulatory provisions or requirements that must be complied with. For instance, where a fund management company pools in clients’ monies and invest through a special purpose vehicle in assets other than (a) conventional and Shariah-compliant securities; (b) derivatives; (c) money market instruments; (d) deposits in conventional and Islamic deposit accounts; and (e) real estate located outside Malaysia, this is considered as circumvention.

Further to the above, there are additional requirements to be complied with when determining the types of investments to be made by the wholesale fund. Key examples are as set out below:

Investment strategies	Requirements
Where a wholesale fund invests 85% or more of its net asset value (“NAV”)[2] in a CIS	The fund manager of that CIS must be suitably authorised, regulated and supervised by a securities regulator which (i) is a signatory to the International Organization of Securities Commission (“IOSCO”) Multilateral Memorandum of Understanding as listed in its Appendix A; or (ii) has a bilateral agreement or arrangement with the SC, in particular, with regard to co-operation on supervision, investigation, enforcement and information sharing.
Where the fund management company or the operator intends to use derivatives	The fund management company or the operator must possess the necessary expertise and experience including understanding the different implications of derivatives positions on the overall investment strategy and ensure that derivatives positions are fairly priced on a consistent basis while bearing in mind the market liquidity of such positions.
Where the financing of the wholesale fund involves extension of credit and other forms of lending or utilises leverage	The fund management company or the operator must (i) determine the borrowing parameters for the wholesale fund (including the maximum amount of leverage, duration, and whether secured or unsecured), the basis of leverage and risks involved; (ii) have the necessary expertise and experience in managing a wholesale fund which employs any leverage strategy; and (iii) understand the impact of such leverage on the overall risk of a portfolio and having the ability to monitor the use of such leverage.
Where the fund management company or the operator invests in real estate outside Malaysia	The fund management company or the operator must ensure that the real estate outside Malaysia is managed by a manager that is licensed, registered, approved or authorised to manage the foreign real estate in its home jurisdiction.

The LOLA Guidelines also provide that a trustee or a custodian must be appointed for a wholesale fund and the trustee or the custodian must be registered with the SC. The obligations and rights of the trustee or the custodian shall be specified in a trust deed or a custodial agreement, and such document shall be in force at all times.

4.    Lodgement of a Wholesale Fund

To lodge a wholesale fund with SC, the lodgement must be made by the fund management company. All information and documents as set out in the Lodgement Kit must be lodged. Information and documents required to be lodged include, among others, the fund name, structure of the fund, investment objective of the fund, asset allocation and the fund’s launch date in Malaysia. Thereafter, a wholesale fund can be offered to sophisticated investors in Malaysia as soon as the required information and documents are lodged online, and as long as the fund is launched within 60 business days from the date of lodgement.

5.    Key Obligations of a Fund Management Company[3]

Valuation and pricing obligations

• Except for investments in real estate outside Malaysia, a fund management company must ensure that the investments of the wholesale fund are fairly valued on a regular basis and in any event, at least once a month. Where a wholesale fund invests in real estate located outside Malaysia, valuation must be conducted at least once every 3 years.

• Further, a fund management company must take all reasonable steps to ensure that the wholesale fund and the units in the wholesale fund are correctly valued and priced. In any event of an incorrect valuation or pricing of the wholesale fund or the units in the wholesale fund, immediate remedial actions must be taken to rectify the same.

Liquidity and dealing obligations

• A fund management company must determine the frequency of and any limitation on subscriptions and redemptions having regard to the investment objectives, financial situation and particular needs of investors.

Registration obligations

• A fund management company must keep a register of investors and enter into the register the details of the investors. For instance, where the investor is an individual, the name, address, and the number of the identity card issued under the National Registration Act 1959 or passport number (for foreigners).

• In addition to the above, the fund management company must enter into such register (i) the number of units held by each investor; (ii) the date on which the name of each investor was entered in the register; (iii) the date on which any person ceased to be an investor in the wholesale fund; and (iv) any other relevant information or particulars of the investor.

• As prescribed under the LOLA Guidelines, all information entered into the register must be kept for a minimum of 7 years.

Reporting obligations

• A fund management company must inform its investors of significant and material changes to the investment objective, investment strategy as well as any changes to the material information previously provided to the investors.

• A fund management company must also ensure that prices, fees and charges be made available to investors periodically.

6.   Perspective

Private investment funds have become increasingly popular as a means to raise and deploy capital. According to the McKinsey’s Global Private Markets Review 2022, after a year of pandemic-driven turbulence that suppressed fundraising activities, private markets rebounded across the board. Global private markets assets under management (“AUM”) reached an all-time high of US$9.8 trillion in the first half of 2021, 33% higher than the year before.

According to the report issued by the Institute for Capital Market Research Malaysia in December 2021, AUM for the Malaysia private equity industry has been growing at a sluggish pace of 6.7% annually from US$3.7 billion in 2010 to US$6.8 billion in December 2020, compared to Singapore (18.6%), Japan (14.9%), South Korea (29.6%), and even ASEAN region as a whole that has recorded growth of over 14.8% over the same period.

The report highlighted that Malaysia faces a unique set of challenges in the private equity industry. One of the key challenges is the absence of alternative fund structure with greater flexibility in capital contributions and profit distributions. Measures adopted in neighbouring jurisdictions in addressing such issue include variable capital companies under the Singapore’s Variable Capital Companies Act 2018 and limited partnerships under the Hong Kong’s Limited Partnership Fund Ordinance. In comparison, Malaysia permits only relatively rigid fund vehicle structure, which would have hampered the attractiveness of Malaysia in the setting up of private funds. As highlighted above, a wholesale fund can only be set up in Malaysia under a trust structure or a custodial structure.

It may be timely for the policymakers to review the regulatory regime in Malaysia to push ahead a friendlier and more attractive regime for private funds. Given its strategic location within the ASEAN region, Malaysia will be well-positioned to benefit from the growth in private capital AUM in Asia, if a modern and transparent legal framework is put in place, supported by attractive tax incentives and robust business environment.

[1] SC’s Wholesale Fund Summary of Statistics as at 30 June 2022

[2] Part 1, Chapter 4, Paragraph 4.03 of the LOLA Guidelines provide that for the purpose of determining the wholesale fund’s NAV, the valuation of the assets and liabilities must be based on a process which is consistently applied; and objective and capable of being verified by investors.

[3] Part 1, Chapter 4 of the LOLA Guideline